Chapter II

Debt Recovery Tribunals

2.76 The Government set up a Working Group (Chairman: Shri S. N. Aggarwal) to review the existing provisions of the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 and the rules framed thereunder in the light of the suggestions received from various quarters, such as, banks, FIs, DRTs and individuals as also to examine the adequacy of the infrastructure available to DRTs. The Working Group suggested amendments to the Act and Rules framed thereunder. The Government has substantially amended the Debts Recovery Tribunal (Procedure) Rules, 2003 to facilitate better administration of the Act including plural remedies for banks. As on June 30, 2003, out of 57,915 cases (involving Rs.82,266 crore) filed by banks to the DRTs, 22,163 cases (involving Rs.19,633 crore) have been adjudicated and the amount recovered so far stood at Rs. 5,787 crore.

The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002

2.77 The Government issued the SARFAESI Act, 2002 which, inter alia, provides, for enforcement of security interest for realisation of dues without the intervention of courts or tribunals. The Government has also notified the Security Interest (Enforcement) Rules, 2002 to enable secured creditors to authorise their officials to enforce the securities and recover the dues from the borrowers. The PSBs and FIs have been advised to take action under the Act and report compliance to the Reserve Bank.

2.78 The Act provides for sale of financial assets by banks / FIs to securitisation companies (SCs) / reconstruction companies (RCs)³. Guidelines have been issued to ensure that the process of asset reconstruction proceeds on sound lines. These guidelines, inter alia, prescribe the financial assets which can be sold to SCs / RCs by banks / FIs, procedure for such sales, prudential norms for the sale transactions and related disclosures (Box II.7).

CDR Mechanism

2.79 A scheme of Corporate Debt Restructuring (CDR) was developed in India based on international experience and detailed guidelines on the same were issued for implementation by banks and FIs in 2001 (Box II.8). The objective of the framework has been to ensure timely and transparent mechanism for restructuring the corporate debts of viable entities, outside the purview of BIFR, DRTs and other legal proceedings.

2.80 Consequent upon the Union Budget announcements, 2002-2003, a High Level Group (Chairman: Shri Vepa Kamesam) was constituted in order to revamp the earlier CDR scheme. Based on the recommendations made by the High Level Group and in consultation with the Government, a revised scheme of CDR was finalised and forwarded to banks in February 2003. The progress made under CDR mechanism up to June 30, 2003 is as under:

Table II.1 : Progress under CDR Scheme
(Amount in Rs. crore)
Particulars	No. of cases	Amount involved
1	2	3
Cases referred to
CDR forum	71	53,736
Final schemes approved	41	38,638
Rejected	18	7,252
Pending	12	7,846

Box II.7: Final Guidelines and Directions for SCs / RCs by the Reserve Bank The Reserve Bank issued the final guidelines and directions to securitisation companies (SCs) and reconstruction companies (RCs) in April 2003. The guidelines have been finalised taking into account the feedback received from banks, FIs and others. The regulations would facilitate the smooth formation and functioning of SCs / RCs. The guidelines and directions cover the aspects concerning asset reconstruction and securitisation as also those relating to registration, owned funds, permissible business, operational structure for giving effect to the business of securitisation and asset reconstruction, deployment of surplus funds, internal control systems, prudential norms, and disclosure requirements for these companies. In terms of the provisions of the SARFAESI Act, 2002, SCs are required to raise funds through the instrument of security receipts. The Reserve Bank has, however, clarified that the SCs / RCs can raise funds through the instrument of security receipts by the trust(s) set up by them. In addition to the guidelines and directions, which are mandatory, the Reserve Bank has also issued guidance notes of recommendatory nature covering aspects relating to acquisition of assets, issue of security receipts, etc. The Reserve Bank is in the process of framing a set of standard guidelines in the matter of takeover of the management, sale or lease of whole or part of the business of the borrower. The SCs / RCs have been advised not to proceed against exercising the measures of takeover of management, sale or lease of the borrowers’ business as provided for in Section 9 of the SARFAESI Act, 2002, until guidelines in this regard are notified by the Reserve Bank. As regards enforcement of security interest, SCs / RCs may follow the Security Interest (Enforcement) Rules, 2002 notified by the Government of India as also the relevant provisions in the SARFAESI Act, 2002.

Box II.8: Resolution of Corporate Distress: East Asian Experience Both firm and country characteristics influence the way corporate financial distress is resolved. Firms differ in their capital and ownership structures, while country differences include variations in legal standards and regulatory framework. Besides the use of bankruptcy procedures, alternative means exist to deal with financial distress; these commonly include: out-of-court settlements with creditors and other stakeholders or re-scheduling or partial write-off of debt. In the aftermath of the Asian crisis, a large number of East Asian corporations experienced financial distress at the same time. Country experiences in East Asia on bankruptcy law, creditor rights and the efficiency of judicial systems suggests wide differences in prevailing practices after the crisis (Table A). Table A: Main Features of Bankruptcy Codes in East Asia           Country Timetable to render Does Management stay Is there automatic Do secured creditors   Judgement in bankruptcy? stay? get priority?               Indonesia 30 working days after a No   No   Costs of proceedings   creditor’s petition is         are paid first, followed   registered (after August 1998)         by claims on wages             and secured creditors               Korea 120 working days after a No   No   Secured creditors   creditor’s petition is registered         paid first               Malaysia 180 working days after a No   No   Secured creditors   creditor’s petition is registered         paid first               Philippines No timetable Yes   Yes   Taxes are paid first,             followed by wages,             cost of proceedings             and secured creditors               Thailand No timetable No   No   Costs of proceedings             are paid first, followed             by taxes, wage claims             and secured creditors Reference: Claessens S., S. Djankor and L. Klapper (2003), ‘Resolution of Corporate Distress in East Asia’, Journal of Empirical Finance, Vol.10.

2.81 The salient features of the revised CDR scheme issued in February 2003 are as follows:

• It will cover multiple banking accounts / syndication / consortium accounts with outstanding exposure of Rs.20 crore and above.
• It will be a voluntary system based on Debtor-Creditor Agreement (DCA) and Inter-Creditor Agreement (ICA).
• CDR will have a three-tier structure consisting of : (a) CDR Standing Forum and its Core Group (the policy-making body), (b) CDR Empowered Group (the functional group deciding on the restructuring of cases referred to the CDR mechanism), and (c) the CDR Cell (the secretariat to the CDR system).
• The revised guidelines provide exit options for lenders who do not wish to commit additional financing or wish to sell their existing stake.
• ‘Stand-still’ agreement binding for 90 days or 180 days by debtors and creditors respectively, under which both sides commit themselves not to take recourse to any legal action during the ‘stand-still’ period.

Credit Information on Defaulters and Role of Credit Information Bureau

2.82 In order to alert banks and FIs and put them on guard against the defaulters to other lending institutions and help them in better management of their NPAs, the Reserve Bank has put in place a scheme on sharing credit data. The scheme aims at collecting from / disseminating to them details about borrowers with outstanding aggregating Rs.1 crore and above which are classified by them as ‘doubtful’ or ‘loss’ assets or where suits have been filed by them. Whereas information on non-suit filed accounts (i.e., doubtful and loss accounts) is disseminated on half-yearly basis, viz., as on March 31 and September 30 (on floppy diskettes for their confidential use), the information on suit-filed accounts is published as on March 31 every year and is updated on quarterly basis. The information on suit-filed accounts is now published in a compact diskette (CD) form and is also available on the Reserve Bank website. The defaulters list (non - suit filed accounts) has been disseminated as on September 30, 2002; the defaulters list (suit filed accounts) as on March 31, 2002 has been published in CD form and is also placed on the Bank’s website. Its quarterly updates up to December 31, 2002, have also been placed on the website.

2.83 Following the recommendations of Working Group on Wilful Defaulters (Chairman: Shri S.S. Kohli), with a view to making the scheme of wilful defaulters effective, the banks and FIs were advised on May 30, 2002, a revised definition of ‘wilful default’, including diversion and siphoning of funds by borrowers and penal measures to be initiated against wilful defaulters by them. In another step in this direction, the Reserve Bank set up a Working Group in response to observations made in the JPC Report regarding diversion of funds by borrowers with malafide intention and recommendation of criminal action against them in case of wrong certification on end-use of funds. The Group submitted its report in April 2003 and their recommendations are under consideration of the Reserve Bank. As a transparency measure, the banks / FIs were advised on July 29, 2003 to put in place a high-level grievances redressal mechanism for giving a hearing to representing borrowers that they have been wrongly classified as wilful defaulters.

2.84 Banks and FIs were advised on June 4, 2002 to submit periodic data on suit-filed accounts of Rs.1 crore and above, till December 2002 and suit filed accounts of wilful defaults of Rs.25 lakh and above, till the quarter ending December 2002 to the Reserve Bank as well as to Credit Information Bureau of India Ltd. (CIBIL) and thereafter to CIBIL only. However, the periodic data relating to non-suit filed accounts for their defaulters lists would continue to be submitted to the Reserve Bank only, as in the past. Furthermore, with a view to broad-base credit information / data with CIBIL, banks and FIs were advised on October 1, 2002 to furnish information in respect of suit-filed accounts between Rs.1 lakh and Rs.1 crore from the period ended March 2002 in a phased manner to CIBIL only. They were also advised on October 1, 2002 to obtain consent of their borrowers and their guarantors for disclosure of their names in case of default, in a phased manner, and submit the progress-returns thereon to CIBIL as per prescribed schedule. This would enable CIBIL to build up comprehensive credit information and a database on all (non-suit filed) borrowal accounts (performing as well as non-performing) and to share it with its members and also to take over credit information dissemination function in its entirety from the Reserve Bank. However, on a review of the position and considering the constraints expressed by banks in adhering to the time schedule for obtaining the consent clause, banks were advised, on February 10, 2003, that the revised schedule for obtaining the consent clause and submission of returns to CIBIL would be operative by September 2004 and December 2004, respectively.

6. Consultative Process in Policy Formulation

2.85 As part of the initiative to strengthen the consultative process to aid policy making, the Reserve Bank has initiated steps to enhance interaction with financial market participants. Periodical meetings are being held between Reserve Bank functionaries, representatives of select banks and experts to monitor the developments in money and credit markets, as also to discuss specific problems affecting the banking industry. These meetings are a step towards enhanced transparency and good governance in the conduct of monetary and financial policies.

Meetings with Bankers on Credit Deployment

2.86 In order to monitor closely credit conditions as also to get regular feedback on the direction of growth sectors and industries, since August 2001 monthly meetings with the executives of select banks (comprising public sector, private and foreign banks) along with IDBI are being held on fifteenth of every month. The number of participating banks was increased from 15 to 21 from February 2003, in view of the interest expressed by some banks in participating in these meetings. These meetings provide a platform to discuss likely credit flow to various industries, expectations on macroeconomic scenario and various policy issues impinging on the banking industry, so as to have the required inputs for formulation of the monetary policy.

Resource Management Discussions

2.87 The Resource Management Discussion meetings are held every year prior to the announcement of the annual Monetary and Credit Policy Statement with select banks. These meetings mainly focus on perception and outlook of the bankers on economy, liquidity condition, credit outflow, development of different markets and direction of interest rates along with their expectations from the policy and suggestions in this respect. During 2002-03 these meetings were conducted with 10 banks (including two foreign banks and two private sector banks) during the second and third week of March 2003. The feedback received from these meetings was taken into consideration while formulating the monetary and credit policy for 2003-04.

7. Credit Delivery

Priority Sector Lending

2.88 As a further step to improve the credit delivery mechanism by simplifying procedures, encouraging decentralised decision making and enhancing competition, the following measures were initiated during the year:

• The limit on advances granted to dealers in drip irrigation / sprinkler irrigation system / agricultural machinery was increased, irrespective of their location, from Rs.10 lakh to Rs.20 lakh, under priority sector lending for agriculture.
• The existing overall limit of Rs.10 lakh in respect of setting up of small business was increased to Rs.20 lakh without any ceiling for working capital. Further, banks are now free to fix individual limits for working capital depending upon the requirements of different activities.
• The individual credit limit to artisans, village and cottage industries was raised to Rs.50,000 from the existing limit of Rs.25,000. This will be under the overall limit of 25 per cent advances to weaker sections under priority sector or 10 per cent of net bank credit.
• In order to increase further credit flow to housing sector, the existing limit of housing loans for repairing damaged houses was increased from Rs.50,000 to Rs.one lakh in rural and semi-urban areas and to Rs.two lakh in urban areas. Further, in view of increasing demand for housing in rural and semi-urban areas and to improve financing to housing sector in these areas, it was decided that the banks, with the approval of their Boards, would be free to extend direct finance to the housing sector up to Rs.10 lakh in rural and semi-urban areas as part of priority sector lending.

Rural Credit

Relief for Drought-Affected Farmers

2.89 As alluded to earlier, the guidelines for relief measures by banks in the drought affected districts (as notified by the State Governments) were issued in November 2002.

2.90 In order to further mitigate the hardship of farmers in drought-affected states, the Government had decided in December 2002, as a one-time measure, to waive completely, the first year’s deferred interest liability on Kharif loans in those States. There will be a cap on the amount to be waived as equivalent to 20 per cent of the total deferred liability of interest for the first year only. This instalment of deferred interest, which is to be waived by banks, would be reimbursed by the Government. No interest would be charged on the deferred interest, and the balance of the deferred interest would be recovered in reasonable instalments.

Working Group to suggest Amendments in the Regional Rural Banks Act, 1976

2.91 With a view to examining the various aspects of functioning of RRBs and to make recommendations that enable these banks to take care of the financial needs of the rural populace, the Government set up a Working Group (Chairman: Shri M.V.S. Chalapathy Rao) to suggest amendments in the Regional Rural Banks Act, 1976 (Box II.9).

Box II.9: Major Recommendations of the Working Group to suggest Amendments in Regional Rural Banks Act, 1976 The scope of financial services to be provided by RRBs, as per the amendments proposed in the preamble to Regional Rural Banks Act, 1976, needs to be widened. Capital adequacy norms, with due adaptation, needs to be introduced in RRBs in a phased manner along with RRB-specific amount of equity based on their risk-weighted asset ratio. Based on financial health of RRBs, differentiated ownership structures should be allowed. Prescribed minimum level of shareholding should be at 51 per cent for sponsor institutions. The area of operation of RRBs need to be extended to cover all districts. Keeping in view the regional character and distinct socio-economic identity of issues, RRBs falling in one socio-economic zone may be amalgamated so as to create one or a few RRBs in each State. RRBs may have a minimum of five and a maximum of eleven Board members, including the Chairman. The number of Directors may not be fixed uniformly for all RRBs as at present. As part of consolidation process, some sponsor banks may be eased out and some FIs and other strategic managing partners may take over as sponsor institutions. The regulatory framework for RRBs must be on the lines of those for commercial banks with provision for such bank-specific relaxations as may be necessary for specific time period. RRBs may also be subjected to the statutory norms of licensing and each RRB should be required to obtain a license from the Reserve Bank under the provisions of the Banking Regulation Act, 1949 within a specific time period. Half-yearly financial audit may be introduced in the RRBs. In order to strengthen the RRBs to cater to the needs of the rural economy for all kinds of financial services, diversification of their business needs to be encouraged without losing focus on fulfilling the financial needs of the rural poor. RRBs may avail of all the services of their sponsor banks / institution or other established and authorised public sector portfolio management service providers based on their own judgement of costs and benefits for professionalisation of the investment function for achieving optional returns on the bank’s resources. Various IT-based innovations may be adopted by RRBs at different stages of their development for providing competitive customer services in a cost-effective manner. The induction of technology in RRBs may be monitored by a national-level Standing Committee that may guide RRBs on various issues arising out of the implementation of computerisation plans by various RRBs.

Rural Infrastructure Development Fund

2.92 Both public and private sector banks that have shortfalls in lending to the priority sector or to agriculture have to contribute specified allocations to the Rural Infrastructure Development Fund (RIDF). The RIDF was established with NABARD for assisting State Governments/ State-owned corporations in quick completion of on-going projects relating to medium and minor irrigation, soil conservation, watershed management and other forms of rural infrastructure. The IX^th tranche of RIDF has been set up during the year 2003-04 in NABARD with a corpus of Rs. 5,500 crore.

2.93 In the case of RIDF-I to VI, the rate of interest on deposits placed in the Fund was uniform for all banks irrespective of the extent of their shortfall. Effective from RIDF-VII, it was decided to link the rate of interest on RIDF deposits to the banks’ performance in lending to agriculture. Accordingly, effective from RIDF-VII, banks are receiving interest at rates inversely proportional to their shortfall in agricultural lending. In the case of RIDF-IX, interest rate on loans out of RIDF have been linked to the Bank Rate and fixed at 2.0 percentage points above the Bank Rate.

Review Group on the Working of Local Area Banks

2.94 Guidelines for establishment of Local Area Banks (LABs) were announced in 1996. Since no comprehensive review of the LAB had been undertaken, a Review Group (Chairman: Shri G. Ramchandran) was appointed by the Reserve Bank in July 2002 with outside experts to study and make recommendations on the LAB scheme. The major recommendations of the Group accepted by the Reserve Bank are as under:

• There should be no licensing of new LABs till measures to strengthen the existing LABs were put through and the existing LABs are placed on a sound footing.
• The existing LABs should be asked to reach net worth of at least Rs.25 crore over a period of five years for attaining viability.
• LABs should maintain a minimum capital adequacy of 15 per cent, and
• LABs need to be treated like any other commercial bank and therefore, regulation and supervision should be entrusted to the same wing of the Reserve Bank which is responsible for regulation and supervision of commercial banks.

Credit to SSIs

2.95 To give the benefit of the soft interest rate policy of the Reserve Bank to small-scale industry (SSI), banks have been advised to set the interest rate on advances to SSI units keeping in view general southward movement in interest rates. Further, as per the announcement made in the Union Budget 2003-04, the Indian Banks Association has already advised the banks to adopt the interest rate band of two per cent above and below its PLR for secured advances. To mitigate the problem of delayed payment, banks have been advised to fix sub-limits within the overall working capital limits to the large borrowers specifically for meeting the payment obligation in respect of purchases from SSI. To make available timely credit to the sector a time frame has been fixed for disposal of loan applications. In the recently announced Mid-term Review of Monetary and Credit Policy for 2003-04 banks have been allowed to increase the loan limit from Rs. 15 lakh to Rs. 25 lakh (with the approval of their Boards) for dispensation of collateral requirement, on the basis of good track record and the financial position of the SSI units. Moreover, all new loans granted by banks to NBFCs for the purpose of on-lending to SSI sector would also be reckoned under priority sector lending.

8. Money and Government Securities Markets

Money Market

Reliance on Call Notice / Money Market

2.96 The Monetary and Credit Policy for 2002-03 stipulated prudential limits in a symmetric way on both borrowing and lending of banks in the call/notice money market. This was done to preserve the integrity of the financial system and to facilitate the development of the term money market as well as the repo market. Accordingly, after consultation with banks, prudential limits in respect of both borrowing and lending came into effect in two stages, effective October 5, 2002 and December 14, 2002. At present, in the second stage, with effect from the fortnight beginning December 14, 2002, lending of SCBs, on a fortnightly average basis, should not exceed 25 per cent of their owned funds. Banks are, however, allowed to lend a maximum of 50 per cent on any day during a fortnight. Similarly, borrowings by SCBs should not exceed 100 per cent of their owned funds or 2 per cent of aggregate deposits, whichever is higher. Banks are, however, allowed to borrow a maximum of 125 per cent of their owned funds on a particular day during a fortnight.

2.97 In order to ensure smooth adjustment to this stipulation without any disruption in asset-liability management (ALM), banks were advised to unwind their position as borrowers and/or lenders in the call/notice money market in excess of the prudential limit, as specified for the first stage, by October 4, 2002. The Reserve Bank may, however, consider allowing temporary access to the call/notice money market in excess of the stipulated limit to any bank facing mismatches, on request. Increased access over stipulated norms may also be permitted by the Reserve Bank for a longer period for banks with fully functional ALM system to the satisfaction of the Reserve Bank.

2.98 With effect from October 5, 2002, Primary Dealers (PDs) are free to lend up to 25 per cent of their net owned funds (NOF) on average basis, during a reporting fortnight. So far as borrowing by PDs in call/notice money market is concerned, in stages I and II, PDs would be allowed to borrow up to 200 per cent and 100 per cent, respectively, of their NOF as at end-March of the preceding financial year. These phases will be effective contingent upon certain developments in the repo market.

Progress Towards Pure-Inter-Bank Call Money Market

2.99 With a view to moving towards a pure inter-bank call/notice money market, non-bank participants are allowed in the second stage to lend, with effect from June 14, 2003, on average in a reporting fortnight, up to 75 per cent of their average daily lending in the call/notice market during 2000-01. The Mid-term Review of Monetary and Credit Policy for 2003-04 has proposed that with effect from fortnight beginning December 27, 2003, non-bank participants would be allowed to lend, on average in a reporting fortnight to 60 per cent of their average daily lending in call / notice money market during 2000-01. The time-table for further phasing out of non-bank participation will be announced in consultation with market participants.

Borrowings by Co-operative Banks from Money Market

2.100 Consequent upon developments relating to co-operative banks during early part of 2001 and in order to reduce excessive reliance of some urban co-operative banks (UCBs) in call / notice money market, it was stipulated on April 19, 2001 that borrowings by UCBs in the call / notice money market on a daily basis should not exceed 2.0 per cent of their aggregate deposits as at end March of the previous financial year. Subsequently, the same stipulation was extended to State Co-operative Banks (StCBs) and District Central Co-operative Banks (DCCBs) on April 29, 2002.

Certificates of Deposit (CDs) Market

2.101 In order to impart transparency and flexibility and encourage secondary market transactions in the financial market, it was stipulated that banks and FIs should issue CDs without prejudice to the Depositories Act, 1996, in dematerialised form effective June 30, 2002. Existing outstandings of CDs in physical form were to be converted into demat form by October 2002.

2.102 In order to increase the investor base, minimum size of issues of CDs by banks and FIs was reduced to Rs.1 lakh in June 2002. The Fixed Income Money Market and Derivatives Association of India (FIMMDA) also issued a standardised procedure, documentation and operational guidelines for issue of CDs in both physical and demat form on June 20, 2002. Further, with a view to providing more flexibility to pricing of CDs and giving additional choice to both investors and issuers, CDs are now permitted to be issued as a coupon-bearing instrument as well and banks may issue CDs on a floating rate basis, provided the methodology of computing the floating rate is objective, transparent and market based. The standardised procedures and documentations in this regard would be issued by FIMMDA in consultation with market participants.

Interest Rate Derivatives

2.103 Following the announcement in the mid-term Review for the year 2002-03, the Reserve Bank had constituted a Working Group on Rupee Derivatives (Chairman: Shri Jaspal Bindra) in November 2002 with appropriate representations from banks, primary dealers, mutual funds and the Reserve Bank. The scope of the Group was expanded to cover the issues relating to exchange-traded interest rate derivatives - in addition to the issues on OTC interest rate derivatives - on the recommendations of the High Level Coordination Committee on Financial and Capital Markets. The Group submitted its Report in January 2003. The major recommendations of the Group are as follows:

• Less complex interest rate options to be permitted in the first phase may include vanilla caps, floors and collars, European Swaptions, call and put options on fixed income instruments / benchmark rates and unleveraged structured swaps based on overnight indexed swaps and Forward Rate Agreements (FRAs) where the risk profile of such structure is similar to that of the building blocks.
• SCBs, FIs and PDs should be allowed to both buy and sell options; corporates may sell options initially without being the net receivers of premium. Mutual funds and insurance companies may also write options as and when their respective regulators allow them.
• Four contracts, viz., a) short-term Mumbai Inter-Bank Offer Rate (MIBOR) Futures Contract, b) MIFOR Futures Contract, c) Bond Futures Contract, and d) Long-Term Bond Index Futures Contract, could be considered for trading on exchanges at the present stage.
• The market regulator should lay down only broad eligibility criteria and the exchanges should be free to decide on the underlying stocks and indices on which futures and options could be permitted.
• Netting should be allowed on intra-day basis at client-level positions.
• ICAI could be requested to develop guidelines for accounting of exchange-based transactions on interest rate derivatives.
• The Reserve Bank may consider mandatory anonymous disclosure of deals done in a standardised manner on the negotiated dealing system platform.
• Brokers accredited by the FIMMDA may be permitted in the OTC derivatives market.
• SEBI may consider issuing guidelines in regard to derivative products that mutual funds can trade in. The IRDA should come out with guidelines for participation of insurance companies in derivatives markets.
• To make the OTC derivatives contracts legally enforceable, amendment to Section 18A of the Securities Contract and Regulation Act, 1956 may be followed up vigorously by the Reserve Bank with the Ministry of Finance. To clarify the status of derivatives contracts in India undertaken by banks / FIs / PDs, the Banking Regulation Act, 1949 may be amended.
• Derivative dealers can choose the pricing and valuation model for interest rate options according to their opinion on the suitability of the models.
• A common minimum information framework and a public disclosure system may be adopted by market participants.

2.104 Meanwhile, guidelines for enabling regulated entities to participate in exchange-traded interest rate derivatives (IRDs) were finalised by the Reserve Bank in consultation with the Government and SEBI. Accordingly, it has been decided to allow SCBs (excluding RRBs and LABs), PDs and specified all-India FIs to deal in exchange-traded IRDs in a phased manner. In the first phase, the SEBI has decided to introduce anonymous order driven system for trading in IRDs on The Stock Exchange, Mumbai (BSE) and National Stock Exchange (NSE). In the first phase, such entities can transact only in interest rate futures on notional bonds and T-Bills for the limited purpose of hedging the risk in their underlying investment portfolio. PDs are, however, allowed to hold trading positions in IRDs subject to some prudential regulations. Allowing transactions in a wider range of products, as also market making for entities other than PDs will be considered in the next stage on the basis of the experience gained.

2.105 For the present, only the interest rate risk inherent in the Government securities classified under the AFS and HFT categories have been allowed to be hedged.

2.106 Interest rate derivative transactions undertaken on the exchanges shall be deemed as hedge transactions, if and only if, a) the hedge is clearly identified with the underlying Government securities in the AFS and HFT categories, b) the effectiveness of the hedge can be reliably measured, and c) the hedge is assessed on an ongoing basis and is ‘highly effective’ throughout the period.

2.107 The existing norm of 5 per cent of total transactions undertaken during a year as the aggregate upper limit for contract for each of the approved brokers should be observed by SCBs and all-India FIs who participate through approved Futures and Options members of the exchanges.

2.108 It is required that the regulated entities should seek approval of their Board of Directors for formulating the policy framework and appropriate risk control measures before trading in interest rate futures on the stock exchanges. the Reserve Bank is in the process of harmonising the regulatory and prudential norms for OTC and exchange-traded derivatives.

Collateralised Borrowing and Lending Obligation (CBLO)

2.109 The mid-term review of Monetary and Credit Policy for 2002-03 had announced the proposal to promote collateralised borrowing/ lending operations by market participants through Collateralised Borrowing and Lending Obligations (CBLO) to reduce their reliance on the call/notice money market. The CBLO has been operationalised as a money market instrument through the Clearing Corporation of India Limited (CCIL) on January 20, 2003. The CBLO may have original maturity between one day and up to one year. The regulatory provisions and accounting treatment for CBLO are the same as those applicable to other money market instruments. However, in order to develop CBLO as a money market instrument, it has been exempted from CRR stipulations subject to bank maintaining minimum CRR of 3 per cent. Securities lodged in the gilts account of the bank maintained with CCIL under Constituents’ Subsidiary General Ledger (CSGL) facility remaining unencumbered at the end of any day can be reckoned for SLR purposes by the concerned bank.

Discounting / Rediscounting Of Bills By Banks

2.110 In December 1999, the Reserve Bank had constituted a Working Group on Discounting of Bills by Banks (Chairman: Shri K.R. Ramamoorthy). The Working Group had examined the suggestions of various banks, FIs and NBFCs in respect of granting freedom to banks in discounting of bills. After considering the recommendations of the Working Group, revised guidelines were issued to banks on January 24, 2003 in supercession of the earlier instructions and banks were advised to adhere to the new guidelines while purchasing/ discounting/negotiating/rediscounting of genuine commercial/trade bills. The important features of the revised guidelines are:

• Banks are presently required to open letters of credit (LCs) and purchase/ discount/negotiate bills under LCs only in respect of genuine commercial and trade transactions of their borrower constituents who have been sanctioned regular credit facilities by them. Accommodation bills should not be purchased/discounted/negotiated by banks.
• The practice of drawing bills of exchange claused ‘without recourse’ and issuing letters of credit bearing the legend ‘without recourse’ should be discouraged because such notations deprive the negotiating bank of the right of recourse it has against the drawer under the Negotiable Instruments Act.
• Bills rediscounting should be restricted to usance bills held by other banks. Banks should not rediscount bills earlier discounted by non-banking financial companies (NBFCs) except in respect of bills arising from sale of light commercial vehicles and two / three wheelers.
• While discounting bills of services sector, banks should ensure that actual services are rendered and accommodation bills are not discounted. Services sector bills should not be eligible for rediscounting and,
• Banks should not enter into repo transactions using bills discounted / rediscounted as collateral.

Government Securities Market

Separate Trading for Registered Interest and Principal of Securities (STRIPS)

2.111 Operational arrangements, including software development on separate trading for registered interest and principal of securities are being formulated. Dates for consolidation of coupon strips (March 25 / September 25 and May 30 / November 30) would be aligned with coupon payment dates in future issuances. The coupon payment dates of 6.01 per cent Government Stock 2028, issued on August 7, 2003, were aligned to March 25 / September 25. PDs, which meet certain laid down financial criteria, would be authorised to undertake stripping and reconstitution of securities. The Public Debt Office of the Reserve Bank would act as a registry of stripped bonds.

Debt Buy Back Scheme of Government of India

2.112 The Union Budget 2003-04 observed that a large proportion of the banks’ holding of Central Government domestic debt, contracted under the high interest rate regime of the past, is thinly traded. Such loans should ordinarily command a premium over their face value with the softening of interest rates. However, owing to limited liquidity, banks are often unable to encash the same. In view of this, the Government proposed to buy back such loans from banks, on a voluntary basis, that are in need of liquidity by offering a premium that was to be set on a transparent basis. If banks declare the premium received as business income, for income tax purposes, it was decided that they would be allowed additional deduction to the extent that such income is used for provisioning of their NPAs.

2.113 After completion of the necessary modalities, on July 19, 2003, the buy back auction of 19 high coupon, relatively illiquid Government securities was conducted by the Reserve Bank. The debt buy back auction was conducted through an interactive platform developed by Clearing Corporation of India Limited (CCIL), where the participants were allowed to revise their bids in a live interactive mode. The details of the auction are given below.

• A total of 131 offers, amounting to a total of Rs. 14,434 crore (face value), were received. The entire amount was accepted as these were at or above the minimum discount of 7.5 per cent stipulated by the Government. The market value of these securities bought back amounted to Rs. 19,394 crore.
• The net cash outflow for the Government amounted to Rs. 2,539 crore after accounting for the outflows due to premium (Rs. 3,472 crore) and accrued interest on securities bought back (Rs. 500 crore), and inflows on securities reissued by way of premium received (Rs. 1,120 crore) and accrued interest (Rs. 313 crore).
• In exchange of the securities bought back, the Government reissued four securities of equal face value (Rs. 14,434 crore), in a pre-announced manner.

Trading of Government Securities on Stock Exchanges

2.114 With a view to encouraging wider participation of all classes of investors, including retail investors in Government securities, it was decided to introduce trading in Government securities through a nation-wide, anonymous, order-driven, screen-based trading system in the stock exchanges in the same manner in which trading takes place in equities. This facility of trading of Government securities on the stock exchanges would be available to banks in addition to the present Negotiated Dealing System of the Reserve Bank, which will continue to remain in place. Accordingly, with effect from January 16, 2003, trading of Government of India dated securities in dematerialised form is being allowed on automated order driven system of the NSE, BSE and Over-the-Counter Exchange of India (OTCEI). The scheme will subsequently be extended to Government of India Treasury Bills and State Government securities.

Guidelines for Uniform Accounting for Repo / Reverse Repo Transactions

2.115 On a review of the accounting practices followed by all Reserve Bank regulated entities for accounting repo / reverse repo transactions, it emerged that there were divergent practices prevailing among them. In order to ensure uniform accounting treatment and impart an element of transparency, guidelines for uniform accounting for repo / reverse repo transactions was finalised in consultation with the FIMMDA. The uniform accounting will be applicable from the financial year 2003-04. The uniform accounting principles for the present would not apply to repo / reverse repo transactions under the Liquidity Adjustment Facility (LAF) with the Reserve Bank.

2.116 The legal character of repo under the current law, as outright purchase and outright sale transactions is kept intact by ensuring that the securities sold are excluded from the Investment Account of the seller of securities and are included in the Investment Account of the buyer of securities. The buyer of the securities can reckon the approved securities acquired for the purpose of Statutory Liquidity Ratio. The securities bought would have to be marked-to-market as per the investment classification guidelines. In case of entities not following any investment valuation norms, the valuation of securities acquired will be in accordance with the norms followed by them in respect of securities of similar nature. Banks are required to make disclosures on the securities sold under repo and purchased under reverse repo in the ‘Notes on Accounts’ to the balance sheet.

9. Legal Reforms in the Banking Sector

2.117 The Committee on Banking Sector Reforms (Chairman: Shri M.Narasimham) in 1998 observed that a legal framework that clearly defined the rights and liabilities of parties to contracts and provides for speedy resolution of disputes is a sine qua non for efficient trade and commerce, especially for financial intermediation. Keeping this in view, several legislative initiatives have been undertaken in the banking and financial sector over the past several years (Box II.10).

2.118 A revised Banking Ombudsman Scheme, 2002 was brought into force by the Reserve Bank in the place of Banking Ombudsman Scheme, 1995 with effect from June 2002. The new Scheme provides for review of an award passed by the Banking Ombudsman. The Scheme also empowers the Ombudsman to act as an arbitrator for resolving disputes between a bank and its constituent as well as between one bank and another bank through the process of conciliation, mediation and arbitration.

Box II.10: Legal Reforms in Banking A. Laws Enacted The Negotiable Instruments (Amendments and Miscellaneous Provisions) Act, 2002, effective from February 6, 2003, introduces the concepts of ‘electronic cheque’ and ‘cheque truncation’ by expanding the definition of ‘cheque’ as given in the extant Act. It also enhances the punishment for dishonour of cheques from one year to two years, excludes the nominee directors from prosecution and provides for speedy and time-bound disposal of criminal complaints by summary trial, day-to-day hearing and complainant’s evidence through affidavit. The Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest (SARFAESI) Act, 2002, effective from the date of promulgation of the first Ordinance, i.e., June 21, 2002, has been extended to cover co-operative banks by a notification dated January 28, 2003. The Prevention of Money Laundering Act, 2002, notified by the Government of India in January 2003, intends to combat menace of crime-related money and provides the enabling legal framework. The Multi-state Co-operative Societies Act, 2002, which came into force with effect from August 2002 in replacement of the Act of 1984, empowers the Central Government to give directions to the multi-state cooperative societies in the public interest or to supersede their Board only with respect to those multi-state co-operative societies in which not less than 51 per cent of the paid-up share capital or of the total shares is held by the Central Government. B. Bills introduced in the Parliament The Financial Companies Regulation Bill, 2000, introduced in Parliament in December 2000, proposes compulsory registration of all financial companies with the Reserve Bank, prior approval of the Reserve Bank for any substantial change in the management, stipulation for minimum requirement of net-owned funds and prohibiting all unincorporated bodies from issuing advertisement in any manner for soliciting public deposits. The Banking Regulation (Amendment) Bill, 2003, has been introduced in Parliament in April 2003. The Bill provides for the removal of the extant restriction that no person holding shares in the banking company is entitled, in respect of any shares held by him, to exercise voting rights on poll in excess of 10 per cent of total voting rights of all the shareholders of that banking company. This amendment is expected to encourage foreign banks to set up their subsidiaries and attract foreign investors. The Banking Regulation (Amendment) and Miscellaneous Provisions Bill, 2003, proposes amending the definition of ‘approved securities’, ‘banking’, and ‘banking policy’; providing for banking company to undertake the business of insurance, derivatives, securitisation transactions, credit, debit and other cards issued by the banks; criminal liability for use of words "bank", ‘banker" and "banking" by any company other than banking company without the approval of the Reserve Bank; prohibition on connected lending and advances to associate companies of the banks; prohibition on acquisition of more than five per cent in the share capital of the banking companies without the approval of the Reserve Bank and empowering the Reserve Bank to supersede the Board of Directors of a banking company in certain circumstances. C. Bills submitted to the Government The Payment and Settlement Systems Bill, 2002, based on the recommendation of the Committee on Payment Systems (Chairman: Dr. R.H. Patil), constituted by the Reserve Bank, calls for the enactment of a separate statute for regulation and supervision of the payment and settlement systems in the country. The Amendments to the Reserve Bank of India Act, 1934 propose separation of the debt management of the Government from monetary management, disclosure of credit information to other central banks or monetary authority outside India on reciprocal basis and other regulatory authorities in India, streamlining the cash reserve ratio by removing the prescribed limit to accord professional flexibility in the management of monetary policy and empowering the Reserve Bank for electronic transfer of fund and multiple payment system. The Bank Deposit Insurance Corporation Bill, based on the recommendations of the Joint Team of the Finance Ministry, the Reserve Bank and the Deposit Insurance and Credit Guarantee Corporation (DICGC), envisages a pro-active role by DICGC requiring power to cancel registration in case of default in payment of premium, sharing of information by the Bank as to the health of the bank, etc.

10. Technological Developments

Payment and Settlement System

2.119 Payment and settlement systems play an important role to ensure that funds move safely, quickly and in a timely manner. Settlement systems in the country have traditionally been Deferred Net Settlement (DNS) systems. The Committee on Payment and Settlement Systems (CPSS) of the Bank for International Settlements (BIS) have come out with a set of Core Principles for Systemically Important Payment Systems. These principles are the current international standards and codes for the deferred net settlement systems in any country. The status of compliance with these principles in the Indian context is detailed in Box II.11.

Retail Funds Transfer System

2.120 The growth in usage of non-conventional modes of retail funds transfer system has been substantial. Electronic Funds Transfer (EFT) using the RBI-EFT scheme has shown the highest jump with a ten-fold rise both in terms of volume and value during 2002-03 as compared with the previous year. ECS (Credit Clearing) grew by 26 per cent in terms of volume, while ECS (Debit Clearing) showed a marked rise of 62 per cent in terms of number of transactions during 2002-03 over the previous year. A new product, the Special EFT (SEFT) covering about 127 centres with more than 2,300 designated branches of banks was introduced during the year to provide quicker transfer of funds in a safe and secure electronic mode. Large-scale usage of cards was also witnessed during the year. While the number of debit cards issued grew at a rate faster than that of credit cards, smart-card based products have just been making their foray in the Indian scenario. The year also witnessed a significant change from individual bank-owned Automated Teller Machines (ATMs) to shared ATMs, where ATMs are shared across many banks and the services are outsourced.

Reports of Committees

Committee on Payment System

2.121 In order to examine various issues relating to the payments system, a Committee on Payment Systems (Chairman: Dr. R.H.Patil) was set up with broad-based representation from the banking industry. The Committee examined the relevant aspects of regulation and supervision of payment and settlement systems. The major recommendations of the Committee were, among others, enactment of a separate statute for regulation and supervision of the payment system in the country. The draft provides legal base for netting, finality of settlement and powers to formulate regulations. The Report of the Committee along with the draft bill has been forwarded to the Government for further action.

Working Group on Cheque Truncation

2.122 With the passage of amendments to the Negotiable Instruments Act, 1881 the Reserve Bank constituted a Working Group on cheque truncation and e-cheques (Chairman: Dr. R.B. Barman). The Working Group in its Report, submitted in July 2003, has recommended, inter alia (i) truncation of physical cheques at the place of first deposit (presenting bank) and settlement on basis of the current structure of MICR fields and (ii) targeting the four metro centres in the first phase including all banks and all clearings at a centre from a cut-off date. A pilot project is also recommended to be implemented within a period of one year at a metro centre and covering two nearby smaller towns so that the impact on inter-city clearing could also be evaluated.

Working Group on Critical Infrastructure in the Financial Sector

2.123 As part of the efforts to have plans for protecting critical computer infrastructure and representing the concerns of the financial sector, a Working Group (Chairman: Shri R. Gandhi) analysed the various issues and submitted its Report to the Government as part of the Working Group on Critical Information Systems Protection set up by the Government. The group has indicated the types of systems which form part of the critical infrastructure, as part of the requirements of the banking and financial sector.

Developments in Technology in Banking

2.124 A number of banks commenced the process of setting up core banking solutions, which are at various stages of implementation. While the new private banks, foreign banks and a few old private sector banks have already such systems in place, the PSBs are also rapidly moving towards the attainment of this requirement. Computerisation of the business of banks has been receiving high importance. While all PSBs have already crossed the 70 per cent level of computerisation of their business, the advice from the Central Vigilance Commission (CVC) to achieve 100 per cent computerisation - has resulted in renewed vigour in these banks to attain this requirement.

Box II.11: Status of Compliance with Core Principles for Systemically Important Payment Systems   Principle   Observation 1. The system should have a well-founded legal basis under all relevant jurisdictions.   The existing deferred net settlement systems are all based on contractual agreements between the participant banks and the manager of the clearing house.         2. System’s rules and procedures should enable participants to have a clear understanding of the system’s impact on each of the financial risks they incur.   The rules and procedures for clearing exist in the form of the model Uniform Rules and Regulations (URR) which are adopted by all clearing houses. These elucidate the duties and responsibilities of all the participants. For electronic based systems, such as, the ECS-Credit and Debit, and EFT- Procedural Guidelines clearly define the rights and obligations of all the participants in the respective systems.         3. System should have clearly defined procedures for management of credit risks and liquidity risks.   Well laid out procedures for management of any situation arising out of such risks exist. The Rule 11 of the model URR provides the facility of partial unwind. The clearing is carried out by withdrawing all instruments drawn on the defaulting bank as though it did not participate in the clearing, thus resulting in the risk not materalising.         4. System should provide prompt final settlement on day of value, preferably during the day and at a minimum, at the end of the day.   All clearings of the major centres of the country, which account for more than 85 per cent of the clearing value perform the accounting of the clearing settlements on the same day itself. The system ensures settlement being accounted for at different time zones, and at the latest, by the end of the day. This includes Delivery versus Payment (DvP) transactions (Government securities), inter-bank clearing and high value clearing also. In case of low-value MICR clearing, the existence of a ‘return clearing’ for unpaid cheques as well as the statutory need for the drawee bank branch to physically verify the payment instrument, require a longer time for settlement finality, which is by the end of the day.         5. System in which multilateral netting takes place should, at a minimum, be able to ensure timely completion of daily settlements if participant with the largest single settlement obligation cannot settle.   Settlement risk is addressed through a system of partial   unwind. There has not been a single instance of failure to   settle on a daily basis in all systemically important payment   systems till date.         6. Assets used for settlement should preferably be a claim on the central bank; where other assets are used, they should carry little or less credit risk.   The final settlement occurs across the books of the Reserve Bank in the major centres and across the books of public sector banks (mainly the SBI) at other centres.         7. System should ensure a high degree of security and operational reliability and should have contingent arrangements for timely completion of daily processing.   High degree of security and reliability is achieved with the state- of-the-art cheque processing system for cheque clearing; other settlements for systemically important systems take place on robust, reliable and secure computer systems.         8. The system should provide a means of making payments which is practical for its users and efficient for the economy.   The existing systems are all the result of many years of their operation and thus are tuned to meet the requirements of the participants as also meet the overall requirements for the economy as a whole. The Reserve Bank as the overseer of the payment system has also taken several initiatives to increase efficiency of the system by inducting newer technology and bringing about changes in procedures.         9. System should have objective and publicly disclosed criteria for participation, which permit fair and open access.   The access criteria laid down for becoming members of the clearing house are explicit and are disclosed. Constituents have to be banks fulfilling certain other minimum criteria (not applicable in case of post offices). For other players such as PDs and mutual funds, explicit rules of eligibility have been laid down by the central bank. The model URR for clearing houses provide for orderly removal of a member from the clearing house in case its continuance may cause dislocation / risk to the smooth functioning of the system.         10. Governance arrangements should be effective, accountable and transparent.   The clearing house is an association of member banks governed by URR. It has a Standing Committee for day-to-day governance and a general body where all major decisions are discussed and approved by the members. The members enter into contracts with the bank managing the clearing house wherein the duties and responsibilities are clearly spelt out.

2.125 Networking in banks is also an important activity which has been receiving focused attention. As part of the Indian Financial Network (INFINET), the number of Very Small Aperture Terminals (VSATs) rose from 924 at end-March 2002 to more than 2000 at end-June 2003. The notification of the Institute for Development and Research in Banking Technology (IDRBT) as the Certification Authority and the establishment of Registration Authorities in various banks during the year would lead to exchange of secured electronic message using digital signatures and Public Key Infrastructure (PKI)-based encryption.

Integration of IT Strategy and Business Strategies of Banks

2.126 The World Bank had sanctioned a Modernisation and Institutional Development Loan (MIDL) of US $ 83.7 million in 1995 under the Financial Sector Development Project to six participating banks (PBs). The financial assistance is intended to help the PBs to build financial strength and long-term competitiveness in a more liberalised business and banking environment.

2.127 During its visit in February 2001, the World Bank Review Team had observed that the computerisation efforts of the PBs had largely gone into house keeping areas like book-keeping and reconciliation. The IT infrastructure was found to be driven by technology and not by business and customer needs. The impact of the computerisation was characterised by a focus on "hardware" installation and was not fully reflected in productivity. They further observed that the progress in networking was not very satisfactory. There was an absence of integration of IT strategies with business strategy of PBs. As a result, even where proper infrastructure had been set up, it was not used by the customers to the extent necessary to break even and hence the consequential benefits were not accruing to banks. The World Bank suggested that the Reserve Bank could take a lead role and issue guidelines to banks, helping them integrate their IT strategy with business strategies. It was, therefore, decided to engage the services of the National Institute of Bank Management (NIBM) to conduct a study on integration of IT strategy with strategic business plans of banks. The purpose of the study is not to analyse the performance of the six participating banks but to consider these banks as case studies. The NIBM forwarded a detailed project report on the subject on May 30, 2003 which is being processed for issue of suitable guidelines to the banks.

11. Other Developments

Immediate Credit for Cheques

2.128 Based on the recommendation of the Indian Banks’ Association (IBA), it has been decided that the present ceiling of Rs.7,500 should be enhanced to Rs.15,000 for immediate credit of outstation / local cheques subject to the existing guidelines issued by the Reserve Bank. These guidelines mainly relate to extension of such facility to all individual depositors without laying any stipulation for minimum balance for the purpose, proper conduct of account of customer, charging of interest for the period the bank is out of funds in the event of cheque being returned unpaid and publicity of availability of such facilities at branches.

Savings Bank Accounts

2.129 Banks have been advised that they should inform customers regarding the requirement of minimum balance at the time of opening the savings bank account and also any subsequent changes in this regard to the account holders in a transparent manner as deemed fit by them.

2.130 Banks have been allowed to open savings bank accounts in the names of State Government departments / bodies / agencies in respect of grants / subsidies released for implementation of various programmes / schemes sponsored by State Governments on production of an authorisation to the bank from the respective Government departments certifying that the concerned Government department or body has been permitted to open savings bank account. An amended directive has been issued to the banks in this regard in December 2002.

Dishonour of Cheques - Streamlining of Procedure

2.131 On January 28, 1992, banks were advised to implement the recommendation of the Goiporia Committee relating to return / despatch of dishonoured instruments to the customer within 24 hours. However, in light of the recommendations of the JPC on the Stock Market Scam and Matters Relating Thereto, the extant instructions relating to return of all dishonoured cheques have been reviewed. It has been suggested that in addition to the existing instructions in respect of dishonoured instruments for want of funds, banks may follow the additional instructions laid down in the circular dated June 26, 2003 which could cover all cheques dishonoured on account of insufficient funds and not only those relating to settlement transactions of Stock Exchanges. These instructions, inter alia, cover procedure for return / despatch of dishonoured cheques, banks’ MIS on such cheques and procedure for dealing with cases of frequent dishonour of cheques.

2.132 Banks have also been advised to adopt, with the approval of their respective Boards, appropriate procedure for dealing with dishonoured cheques with inherent preventive measures, lay down requisite internal guidelines for their officers and staff and ensure strict compliance thereof.

Zero per cent Interest Finance Schemes for Consumer Durables

2.133 Banks were advised to charge interest on loans for purchase of consumer durables without reference to their PLR regardless of size of the loan amount. It was observed that some of the banks were providing low / zero per cent interest rates on consumer durables advances to borrowers through adjustment of discount available from manufacturers / dealers of consumer goods. Some of the banks promote such schemes by releasing advertisement in different newspapers and media indicating that they were promoting / financing consumers under such schemes. Since such loan schemes lack transparency in operations and distort pricing mechanism of loan products, banks were advised to refrain from offering such products.

Credit Facilities to Indian Joint Ventures / Wholly-owned Subsidiaries Abroad

2.134 The existing exchange control regulations permit Authorised Dealers to undertake investments in overseas markets subject to limits approved by their respective Boards. In view of the above, it was decided to revise the existing ceiling from 5 per cent of their unimpaired Tier - I capital to 10 per cent of unimpaired capital funds (Tier I and Tier II capital) for banks to offer credit / non-credit facilities to Indian joint ventures / wholly owned subsidiaries abroad, subject to the prescribed conditions. This facility has been permitted to banks to provide additional avenues for deployment of funds held in Foreign Currency Non-Resident (Bank) Deposit (FCNR(B)), Exchange Earners Foreign Currency (EEFC) and Resident Foreign Currency (RFC) accounts. The position would be reviewed after one year.

‘Know Your Customer’ - Identification of Depositors

2.135 As part of the ‘Know Your Customer’ (KYC) principle, the Reserve Bank has issued several guidelines relating to identification of depositors and advised the banks to put in place systems and procedures to control financial frauds, identify money laundering and suspicious activities and scrutinize / monitor large-value cash transactions. They have also been advised from time to time to be vigilant while opening accounts for new customers to prevent misuse of the banking system for perpetration of frauds. Taking into account recent developments, both domestic and international, it was decided to reiterate, reinforce and consolidate the extant instructions on KYC norms and cash transactions with a view to safeguarding banks from being unwittingly used for the transfer or deposit of funds derived from criminal activity (both in respect of deposit and borrowal accounts), or for financing of terrorism.

Bank Finance for PSU Disinvestment Programme of Government of India

2.136 Disinvestment in public sector undertakings (PSUs) has relevance for the economic reform process of the country and availability of bank finance to the bidders would help in the successful completion of the disinvestment programme. Banks were, therefore, allowed to extend finance to the successful bidders for acquisition of shares of PSUs under the Government of India’s disinvestment programme. It was, however, specified initially that shares pledged to the bank should be marketable without lock-in period. The guidelines were subsequently relaxed allowing banks to extend finance to the successful bidders even though the shares of the disinvested company acquired / to be acquired by the successful bidder are subjected to a lock-in period / other such restrictions which affect their liquidity, subject to fulfillment of certain conditions.

2.137 Banks are precluded from financing investments of NBFCs in other companies and inter-corporate loans / deposits to / in other companies. The position was reviewed and banks are advised that Special Purpose Vehicles (SPVs) which comply with the certain conditions would not be treated as investment companies and therefore would not be considered as NBFCs, and such SPVs would be eligible for bank finance for PSU disinvestment by the Government of India.

12. Implementation of Recommendations of Joint Parliamentary Committee

2.138 The Parliament constituted a Joint Committee on ‘Stock Market Scam and Matters Relating Thereto’ (Chairman: Shri P. M. Tripathi) on April 27, 2001 with Members of Parliament as members. The terms of reference of the JPC were:

• To go into the irregularities and manipulations in all their ramifications in all transactions, including insider trading, relating to shares and other financial instruments and the role of the banks, brokers and promoters, stock exchanges, FIs, corporate entities and regulatory authorities;
• to fix the responsibility of the persons, institutions or authorities in respect of such transactions;
• to identify the misuse, if any, of and failures / inadequacies in the control and supervisory mechanism;
• to make recommendations for safeguards and improvements in the systems to prevent recurrence of such failures;
• to suggest measures to protect small investors; and
• to suggest deterrent measures against those found guilty of violating the regulations.

2.139 After several rounds of deliberations with various agencies and others, the Committee submitted its Report to Parliament on December 19, 2002. The JPC made in all 275 observations / recommendations; about one-third of which pertain to the Reserve Bank. These observations / irregularities mainly concern violations of the Reserve Bank norms / guidelines on banking transactions by a few commercial / co-operative banks particularly in collusion with certain stock brokers, laxity in follow-up of inspection reports, diversion of funds by borrowers, lack of coordination / effective monitoring / prompt action on the part of various regulators to check the scam, etc. The Committee, inter alia, recommended strengthening of supervision / monitoring systems of banking and financial sectors, legislative reforms to strengthen the supervision system, action against officials / borrowers involved in scam-related transactions, anticipation and pre-emptive action in a coordinated manner by regulators, insurance cover for depositors of NBFCs and corporate governance in banks.

2.140 The implementation of the recommendations of the JPC on Stock Market Scam and matters relating thereto has been taken up on an urgent basis to remove certain irregularities that have occurred in the transitional phase (Box II.12).

Box II.12: Progress Report on the Recommendations of the Joint Parliamentary Committee (JPC) on the Stock Market Scam and Matters Relating Thereto The Reserve Bank has taken the following major measures on the recommendations of JPC: (a) Urban Co-operative Banks (UCBs) (i) UCBs have been advised to designate a senior official as compliance officer who should ensure to furnish compliance to the observations made in the inspection report to the Reserve Bank within the prescribed time limit. (ii) UCBs have been advised to furnish important findings of the inspection of UCBs to the Chief Secretary of the State concerned. (iii) Concurrent audit has been introduced for all UCBs. (iv) Instructions have been introduced to the UCBs making it obligatory on the part of Audit Committee to monitor implementation of the Reserve Bank guidelines. (v) UCBs have been advised that they should rectify the deficiencies / irregularities observed during the inspection in all respects for specific compliance in each case within a maximum period for four months from the date of inspection. (vi) The UCBs have been advised to co-opt two professional directors with experience in banking and related areas with a view to improving the governance standards in the banks. (vii) The Reserve Bank has also initiated steps to strengthen off-site surveillance of UCBs. With this end in view, an Off-Site Surveillance Division (OSS) has been set up in the Reserve Bank to detect early warning signals which will facilitate initiation of immediate corrective action. (viii) The Reserve Bank has also initiated a Technical Assistance Programme (TAP) to strengthen the Management Information System (MIS) in UCBs in collaboration with external training institutions like the National Institute of Bank Management (NIBM), Pune, so as to ensure a robust MIS in UCBs as a support for decision making and regulatory compliance. (ix) With effect from June 2002, an asset-liability management system has been introduced in scheduled UCBs under which the UCBs are required to manage their asset-liability mismatches within acceptable tolerance levels. (x) The Regional Offices of the Reserve Bank have been advised to monitor the credit-deposit (CD) ratio of all UCBs to ensure that the high level of CD ratio is not being achieved by violating the statutory requirements on maintenance of cash reserve and liquid assets. (xi) Instructions have been issued to UCBs regarding the ban on granting of loans and advances to the directors and their relatives on concerns in which they have interest. (b) Commercial Banks (i) Banks have been advised to put in place appropriate risk management systems to identify, measure, monitor and control the various risks to which they are exposed and also apprise their Boards in regard to the robustness of risk management systems and their compliance with RBI guidelines. (ii) The effectiveness of risk management system would be examined specifically during the Annual Financial Inspection of the bank. (iii) Detailed guidelines have been issued for uniform compliance with accounting standards. (iv) Adoption of the prescribed system and risk control procedures for capital market exposures within the limits prescribed by the Reserve Bank in its circular of May 11, 2001 has been reiterated. (v) Detailed instructions have been issued regarding the procedure to be followed by banks in respect of dishonoured cheques. (c) Overseas Corporate Bodies (OCBs) (i) Investments under the portfolio investment scheme by OCBs were banned with effect from November 29, 2001. Subsequently, with effect from September 16, 2003, OCBs are not permitted to make fresh investment under FDI scheme (including automatic route) and in other investments / deposits / loans under the various routes / schemes available to the non-residents under the extant Exchange Control Regulations. Further, the facility of opening and maintaining fresh Non-Resident (External) Accounts (NRE) (Savings, Current, Recurring or Fixed), Foreign Currency (Non-Resident) Accounts (Banks) [FCNR(B)] and Non-Resident Ordinary (NRO) Accounts with Authorised Dealers (ADs) in India by OCBs, stands withdrawn. (ii) A floppy-based system for collection of sale / purchase statistics in respect of NRIs / OCBs (only sales in case of OCBs) from banks has since been introduced. A software has since been developed to receive the data by e-mail. In respect of Foreign Institutional Investors also, where data collection is through floppy-based system, it is proposed to convert this procedure to enable receipt of data through the e-mail module and the revised procedure is expected to be introduced shortly. The process of monitoring would be improved further once the Integrated Foreign Exchange Management System (IFMS) facilitated web-based reporting is operationalised. (d) Other Measures (i) The Reserve Bank has constituted various Working Groups to look into the systemic areas, e.g., penal measures and criminal action against the borrowers who divert the funds with malafide intention, preparation of pilot policy statement on take over / merger of banks, identifying existing constraints in laws relating to regulation of financial markets, examination of existing system of supervision over UCBs, etc. Their recommendations are under examination / finalisation. (ii) The Reserve Bank has forwarded to the Government of India amendments relating to Banking Regulation Act, in areas like enhancement of penal provision for false returns, non-compliance with the Reserve Bank instructions / directives and role of Nominee Directors.

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* The primary focus of the Chapter is on policy developments during 2002-03; nevertheless, wherever necessary, references are made to the recent policy developments.

¹ While the policy measures are discussed in this Chapter with respect to fiscal 2002-03 (April-March) and 2003-04 (so far), the supervisory details are discussed over the period covering July 2002-June 2003, since the Reserve Bank’s accounting year spans over July-June.

² The categories are as follows: 1. Business Strategy; 2. Long-term Information System (IS) Strategy; 3. Short-term IS Strategy; 4. IS Security Policy; 5. Implementation of Security Policy; 6. IS Audit Guidelines; 7. Acquisition and Implementation of Packaged Software; 8. Development of software - in-house and outsourced; 9. Physical Access Controls; 10. Checklist for Operating System; 11. General Checklist for Application Systems Controls; 12. Database Controls; 13. Checklist for Network Management; 14. Maintenance related; and 15. Internet Banking.

³ Chapter VI looks into the details of the SC / RCs.