1. Introduction

3.1 The revival of industrial activity induced a distinct shift in the operating macroeconomic environment for commercial banks in 2002-03. Along with continued strong capital flows, there was a revival of non-food credit offtake during the year. Commercial banks were able to fund this increased demand from industry without impinging on liquidity conditions by unwinding positions - in both domestic and foreign investments - built up during the previous years of poor credit off-take. Their performance during the year, thus, reflected the mix of a falling interest rate regime and a revival of credit demand. Easy liquidity conditions continued though the first half of 2003-04, driven by strong capital flows.

3.2 The net profits of scheduled commercial banks (SCBs), excluding Regional Rural Banks (RRBs) continued to record substantial growth during 2002-03 over and above the strong performance last year. The return on assets witnessed a marked improvement driven by increases in all major income categories. The spurt in the retail and housing segments boosted both lending and fee incomes. Trading income continued to be strong in consonance with a sustained rally in the Government securities markets, reflecting the softening of the interest rate regime. Interest expenses decelerated sharply with the reduction in deposit rates (Table III.1).

Table III.1: Changes in the Income Expenditure Profile of Scheduled Commercial Banks
(Amount in Rs. crore)
	Indicator		2001-02		2002-03
			Absolute	Per cent	Absolute	Per cent
	1		2	3	4	5
1.	Income (a+b)		18,956	14.3	21,342	14.1
	a)	Interest Income	11,867	10.3	13,760	10.8
	b)	Other Income	7,089	41.7	7,582	31.5
2.	Expenses (a+b+c)		13,783	11.0	15,841	11.4
	a)	Interest Expenses	9,375	12.0	6,091	7.0
	b)	Operating Expenses	-499	-1.5	4,406	13.1
	c)	Provisions and Contingencies	4,907	36.7	5,344	29.3
3.	Operating Profits		10,080	51.0	10,845	36.3
4.	Net Profits		5,173	80.8	5,501	47.5

3.3 Banks have been taking pro-active steps to align their risk management processes in line with international best practices. In tandem with the changing face of competition, banks have also undertaken significant initiatives to strengthen their business practices. This included greater product sophistication with increasing leveraging of information technology to deliver value-added services to customers. Besides, there was a greater emphasis on integrated risk management systems to monitor credit, market and operational risks, sharper focus on recovery management including setting up of specialised asset recovery management branches, and on corporate governance practices.

2. Assets and Liabilities of Scheduled Commercial Banks¹

3.4 The size of the balance sheet of SCBs recorded slower growth during 2002-03 as compared with that of the previous year, adjusted for merger effects. However, all bank groups, except foreign and new private banks, witnessed double-digit asset growth (Table III.2).

Table III.2: Consolidated Balance Sheet of Scheduled Commercial Banks
(Amount in Rs.crore)
Item			As at end-March 2002		As at end-March 2003
			Amount	per cent	Amount	per cent
				to total		to total
1			2	3	4	5
Total Liabilities			15,36,425	100.0	16,98,916	100.0
1.	Capital		21,472	1.4	21,594	1.3
2.	Reserves & Surplus		62,684	4.1	76,288	4.5
3.	Deposits		12,05,930	78.5	13,55,880	79.8
	3.1	Demand Deposits	1,52,929	10.0	1,64,590	9.7
	3.2	Savings Bank Deposits	2,55,598	16.6	3,02,303	17.8
	3.3	Term Deposits	7,97,403	51.9	8,88,987	52.3
4.	Borrowings		1,02,226	6.6	87,476	5.1
5.	Other Liabilities and Provisions		1,44,113	9.4	1,57,678	9.3
Total Assets			15,36,425	100.0	16,98,916	100.0
1.	Cash and balances with RBI		86,761	5.7	86,118	5.1
2.	Balances with banks and
	money at call and short notice		1,18,576	7.7	74,554	4.4
3.	Investments		5,87,253	38.2	6,93,791	40.8
	3.1	In Government securities (a+b)	4,31,796	28.1	5,36,381	31.6
		a. In India	4,28,418	27.9	5,33,143	31.4
		b. Outside India	3,378	0.2	3,238	0.2
	3.2	In other approved securities	21,753	1.4	19,276	1.1
	3.3	In non-approved securities	1,33,704	8.7	1,38,134	8.1
4.	Loans and Advances		6,45,438	42.0	7,40,473	43.6
	4.1	Bills purchased & discounted	53,094	3.5	58,783	3.5
	4.2	Cash Credit, Overdrafts, etc.	3,22,199	21.0	3,51,519	20.7
	4.3	Term Loans	2,70,145	17.6	3,30,171	19.4
5.	Fixed Assets		20,091	1.3	20,278	1.2
6.	Other Assets		78,306	5.1	83,702	4.9
Source: Balance sheets of respective banks.

3.5 The size of bank assets of an economy is a measure of financial maturity. The size of bank assets in relation to GDP has important implications for financial development of any economy. The ratio of bank assets to GDP at market prices, at about 70 per cent for India, compares favourably with those of developing countries in Asia and Latin America (Chart III.1).

3.6 The changes in the composition of the balance sheet of SCBs, by and large, reflected the changing macroeconomic environment. Deposits continued to account for about four-fifth of the liabilities. The share of Government paper in total assets continued to climb in response to the rally in the Government securities markets. At the same time, the share of bank credit in total assets also recorded an increase with the revival of industrial activity. This was funded by an unwinding of positions in the call/term money markets, and a drawdown of nostro balances abroad in respect of all bank groups [Appendix Table III.1(A) to III.1(C)]. The increase in profitability in recent years raised the share of reserves and surpluses with banks well above the average recorded during the past five years.

Bank-group wise Position

3.7 The broad overall trends held, more or less, for all bank groups during 2002-03. Reflecting the improving investment climate, the advances portfolio of the public sector banks (PSBs) witnessed a turnaround after several years. A similar phenomenon was evidenced for old private banks as well. New private banks did witness an increase in term deposits, with an accompanying increase in term loans. Foreign banks continued to be active in the Government securities market, although their share in total assets was lower than that of PSBs.

Intra-year Variations²

3.8 The dynamics of the balance sheet flows indicate a stronger growth of credit and investments during 2002-03 (Table III.3). During 2003-04 so far, deposit growth remained on the moderate side and bank credit off-take was subdued.

Table III.3: Select Banking Indicators
(Amount in Rs. crore)
Indicator				Outstanding	Financial Year
				as on March	Flows (per cent)
				21, 2003	2001-02	2002-03
1				2	3	4
1.	Aggregate Deposits			12,80,853	14.6	16.1
	(a+b)					(13.4)
	a)	Demand Deposits		1,70,289	7.4	11.3
	b)	Time Deposits		11,10,564	15.9	16.9
						(13.7)
2.	Bank Credit (a+b)			7,29,215	15.3	23.7
	a)	Food Credit		49,479	35.0	-8.3
	b)	Non-food Credit		6,79,736	13.6	26.9
3.	Investments in
	Government Securities			5,23,417	20.9	27.3
Note			:Figures in brackets exclude the impact of mergers since May 3, 2002.
Source:			Section 42 (2) returns of commercial banks.

Deposits

3.9 Deposit mobilisation (net of impact of mergers) by SCBs during 2002-03 was, more or less, in line with the projection of deposit growth, at 14.0 per cent, envisaged in the Monetary and Credit Policy Statement of April 2003 (Appendix Table III.2). The lower deposit growth during 2002-03 partly reflected the deceleration in the monetary base. Time deposits (net of mergers) decelerated reflecting a number of factors, such as, lower accrual of interest in view of the recent softening of deposit rates, and a shift to current accounts in consonance with higher industrial activity. Consequently, demand deposits registered a healthy growth, reflecting the higher non-food credit off-take, fuelled by the revival of industrial production. Deposit expansion remained subdued in 2003-04 so far, primarily reflecting the deceleration in time deposits in response to lower interest rates and impact of the last year's drought. Demand deposits, on the other hand, have remained buoyant during the current year.

Certificates of Deposit (CDs)

3.10 CDs issued by SCBs continued to decline during 2002-03 with the prevalence of easy liquidity conditions - although there was a mild revival in 2003-04 so far (Appendix Table III.3). The discount rates on CDs also continued to soften. The main issuers, as in the past, were mainly banks with a relatively modest retail base, such as, UTI Bank, ICICI Bank, IndusInd Bank, Centurion Bank and Karnataka Bank during 2002-03, and ICICI Bank, UTI Bank, IndusInd Bank, Canara Bank and CitiBank N.A. during 2003-04 so far.

Standing Liquidity Facilities

3.11 The Reserve Bank has been in the process of phasing out sector-specific refinance facilities. The Collateralised Lending Facility (CLF), hitherto available to scheduled commercial banks against the collateral of excess holdings of Government of India dated securities/ Treasury bills (over their investments as part of Statutory Liquidity Ratio (SLR) required to be maintained), has been withdrawn in a phased manner, completely, effective from October 5, 2002. The Export Credit Refinance (ECR) Facility, provided on the basis of banks' eligible outstanding Rupee export credit, both at the pre-shipment and post-shipment stages, remains the only standing facility.

3.12 The apportionment of the standing facilities into normal and back-stop facilities was altered from the initial ratio of two-third to one-third (i.e., 67:33) to one half (i.e., 50:50) each, effective from November 16, 2002. While the normal facility continues to be provided at the Bank Rate, in view of the need to rationalise the multiplicity of rates at which liquidity is injected, effective from April 30, 2003, the following measures were taken in order to increase the efficacy of Liquidity Adjustment Facility (LAF) operations:

• The 'back-stop' interest rate is placed at the reverse repo cut-off rate at which funds were injected earlier during the day in the regular LAF auctions,

• Where no reverse repo bid is accepted as part of LAF auctions, the 'back-stop' interest rate would generally be 2.0 percentage points over the repo cut-off rate of the day under the LAF.

• On the days when no bids for repo or reverse repo auctions are received/ accepted, the 'back-stop' interest rate would be decided by the Reserve Bank on an adhoc basis.

3.13 With effect from April 1, 2002, scheduled banks are provided export credit refinance to the extent of 15.0 per cent of the outstanding export credit eligible for refinance as at the end of the second preceding fortnight. In response to suggestions received from the exporting community (after deregulation of interest rates on post-shipment Rupee export credit beyond 90 days and up to 180 days), with effect from May 1, 2003, the Reserve Bank announced that the refinance facility would continue to be extended to eligible export credit remaining outstanding under post-shipment Rupee credit beyond 90 days and up to 180 days.

3.14 There was a substantial increase in aggregate export credit, consistent with high export growth during 2002-03. The export credit refinance limit, however, declined steadily during 2002-03 (and 2003-04 so far) as a large part of the drawals were in the form of pre-shipment credit in foreign currency and export bills rediscounted which are not eligible for refinance (Appendix Table III.4). The average daily utilisation of the export credit refinance facility picked up in May 2002 (48 per cent of the limit as on May 17, 2002) on account of a temporary hardening of interest rates arising out of border tensions but thereafter declined to negligible levels with the return of easy liquidity conditions. The average daily utilisation of liquidity support under the CLF provided to SCBs ranged between Rs.30 crore and Rs.175 crore during April-May 2002 and was virtually vacated when it was withdrawn completely on October 5, 2002.

Bank Credit

3.15 Bank credit (net of impact of mergers) increased during 2002-03. There was, however, a change in the composition of the credit off-take. Food credit recorded a drop on account of lower procurement operations during the year. Non-food credit, on the other hand, registered a pick-up, reflecting a turnaround in the industrial climate, especially during the latter half of the year. Besides, there was a sharp increase in foreign currency credit demand reflecting relatively lower cost of funds to the borrower vis-à-vis Rupee loans. During 2003-04 so far, bank credit growth remained moderate. Food credit contracted owing to lower procurement and higher off-take. Non-food credit off-take remained relatively subdued amidst buoyancy in industry reflecting, inter alia, increased recourse by corporates to internal sources of financing as well as external commercial borrowings. More recently, i.e., since September 2003, some signs of a pick-up in non-food credit are clearly discernible.

Other Investments

3.16 Besides conventional credit, banks have been investing significantly in non-SLR investments in the form of commercial paper, shares, bonds, and debentures issued by the private corporate sector and public sector undertakings (PSUs) (Table III.4). The sharp increase in such investments during 2002-03 reflects partly the impact of merger effects. In particular, there was a substantial drop in investments in CP, reflecting a decline in issuances during the latter half of the year. Non- SLR investments showed some decline in 2003-04 primarily on account of a fall in the holdings of bonds and debentures of the private corporate sector.

Table III.4: Scheduled Commercial Banks’ Select Non-Slr Investments
(Rs. crore)
	Instrument		March 22, 2002	March 21, 2003
	1		2	3
1.	Commercial Paper		8,497	4,007
			(10.5)	(4.3)
2.	Investment in shares issued by (a+b)		5,914	9,019
			(7.3)	(9.7)
	a) Public sector undertakings		1,587	1,430
			(2.0)	(1.5)
	b) Private corporate sector		4,327	7,589
			(5.3)	(8.2)
3.	Investments in bonds/debentures issued by (a+b)		66,589	79,828
			(82.2)	(86.0)
	a) Public sector undertakings		39,520	46,854
			(48.8)	(50.5)
	b) Private corporate sector		27,069	32,973
			(33.4)	(35.5)
Total (1+2+3)			81,000	92,854
			(100.0)	(100.0)

Note:		Data are based on statutory Section 42 (2) returns submitted by scheduled commercial banks.
		Figures in brackets are percentages to the total. Constituents, may not add to total due to rounding off of figures.

Commercial Paper (CP)

3.17 Banks' investments in CPs issued by the corporates declined during 2002-03, especially during the second half of the year. This reflected, in part, a fall in primary issuances by manufacturing companies having access to sub-PLR lending etc. The principal investors of CP included the following banks, viz., State Bank of India, HDFC Bank, Union Bank of India, Punjab National Bank and Central Bank of India. The top five issuers of CP were EXIM Bank, IDBI, Indian Petroleum Corporation Ltd. (IPCL), the erstwhile ICICI Ltd. and HDFC. The discount rate on CP invested by SCB’s declined steadily from 7.4-10.3 per cent in March 2002 to 6.0-7.8 per cent by March 2003, and further to 4.7-6.5 per cent by September 2003. The spread of the weighted average discount rate (WADR) between the prime-rated and medium-rated companies widened to 156 basis points by end-November 2002 from 89 basis points in mid-April 2002, but narrowed to 59 basis points by end-March 2003 and thereafter to 65 basis points as at end-September 2003.

Commercial Bills

3.18 The market for bills rediscounting recorded a general decline in activity during 2002-03. However, during 2003-04 so far, it showed a marked increase from an average of Rs.281 crore during the first quarter of 2003-04 to Rs. 567 crore during the following quarter. The share of SIDBI, at 78.2 per cent of the total transactions during 2002-03 and 84.5 per cent of total transactions during the first half of 2003-04, continued to be substantial.

Forward Rate Agreements (FRAs) / Interest Rate Swaps (IRS)

3.19 There was a sharp increase in volume in the markets for futures products, such as, FRAs and IRS during 2002-03. While there was a spurt in both the number of contracts and the outstanding notional principal amount, participation in the market continues to remain restricted mainly to select foreign and private sector banks and a primary dealer. In a majority of these contracts, the NSE-Mumbai Inter-Bank Offered Rate (MIBOR) and Mumbai Inter-Bank Forward Offered Rate (MIFOR) were used as the benchmark rates. The other benchmark rates used include the 1-year Government of India security secondary market yield and primary cut-off yield on 364-day Treasury Bills. FRA/ IRS transactions continued to increase sharply to 12,951 contracts at Rs.3,33,736 crore as on September 19, 2003.

Sectoral Deployment of Gross Bank Credit

3.20 The gross bank credit of select SCBs (covering major banks accounting for 85-90 per cent of bank credit of all SCBs) recorded marginally higher growth during 2002-03 as compared with the previous year (Table III.5 and Appendix Table III.5). There was a sharp acceleration in non-food credit, driven mainly by an acceleration in advances to industry (medium and large) and housing.

3.21 Fiscal 2002-03 witnessed a sharp pickup in housing loans, which witnessed a quantum rise to 6.1 per cent of non-food gross bank credit as at end-March 2003, up from 4.6 per cent as at end-March 2002, reflecting several policy initiatives in this regard. In fact, banks have consistently exceeded the targets prescribed for providing housing loans during 2001-02 and 2002-03 (Table III.6).³

Changing Pattern of Export Financing

3.22 The share of export credit in net bank credit remained at a level of 8.0 per cent as in the previous year, notwithstanding higher export growth during the year (Chart III.2). This might be due to the changes in the financing pattern of exports brought about by the liberalised policy regime, softening of domestic and global interest rates and availability of alternative sources of finance at competitive rates.

Table III.6: Housing Finance by Scheduled Commercial Banks
(Amount in Rs. crore)
Item		April-March
		2001-02	2002-03
1		2	3
Minimum Prescribed		5,046	8,574
Allocation		(31.1)	(69.9)
Disbursements		14,746	33,841
		(51.9)	(129.5)
Notes :	1. Data are provisional.
	2. Figures in brackets indicate percentage
	changes over the previous year.

Industry-wise Deployment of Credit

3.23 The increase in industrial credit was, by and large, spread across all sectors (Chart III.3 and Appendix Table III.6). Industry-wise, significant credit growth was observed in electricity, cotton textiles, infrastructure and iron and steel. However, four out of 26 industries, i.e., coal, engineering, tobacco and tobacco products and sugar recorded a decline in credit during 2002-03.

Table III.5: Sectoral Deployment of Gross Bank Credit: Flows
(Variations over the year)
(Amount in Rs. crore)
	Sector		2001-02		2002-03
			Absolute	Per cent	Absolute	Per cent
	1		2	3	4	5
1.	Priority sector		20,845	13.5	28,540	16.3
2.	Industry (Medium and Large)		9,487	5.8	28,011	16.3
3.	Housing		6,203	38.4	12,308	55.1
4.	Non-banking financial companies		1,843	23.6	4,399	45.6
5.	Wholesale trade (other than food procurement)		2,614	14.6	1,939	9.5
6.	Other sectors		12,595	18.0	9,481	11.5
7.	Total (1 to 6)		53,587	12.5	84,678	17.5
	of which:
	Export Credit		-343	-0.8	6,424	14.9

Note:		Data are provisional and relate to select scheduled commercial banks which account for 85-90 per cent of bank
		Credit of all scheduled commercial banks.

Bank Credit to Sick/Weak Industries

3.24 There has been a decline in the number of sick-SSI and non-SSI (sick / weak) industrial units financed by SCBs in recent years (Appendix Table III.7). The quantum of bank loans locked up in sick/weak industries increased marginally to Rs.26,065 crore as at end-March 2002.

Lending to Sensitive Sectors

3.25 The overall exposure of SCBs to sensitive sectors comprising capital market, real estate and commodities, underwent a compositional shift during 2002-03 (Table III.7 and Appendix Table III.8). There was a jump in housing finance - so much so that the overall exposure to sensitive sectors of most bank groups has gone up. PSBs continued to account for about two-thirds of the total exposure of SCBs to sensitive sectors.

Table III.7: Lending to Sensitive Sectors by Scheduled Commercial Banks
(Amount in Rs. crore)
	Advances to	Outstanding as at end-March		Per cent to total
		2002	2003	2002	2003
	1	2	3	4	5
1.	Capital market	3,082	2,504	14.8	10.5
2.	Real estate	9,012	12,464	43.3	52.0
3.	Commodities	8,727	8,979	41.9	37.5
	Total (1+2+3)	20,821	23,947	100.0	100.0

3.26 Most bank groups, excluding the foreign bank category, unwound their exposure to the capital market during 2002-03, partly on account of the subdued performance of the capital market with limited activity being witnessed during 2002-03 and partly on account of the new growth driver: housing finance. Most commercial banks are engaged in offering retail credit for housing on highly competitive prices and customer-friendly terms, supported by strong marketing efforts to enhance their customer appeal. Consequently, real estate lending by most bank groups experienced moderate to significant increases, a decline being evidenced only in case of old private banks who, in fact, experienced a cutback in their overall lending to sensitive sectors. Exposure to commodities was on the lower side for most bank groups, with declines being evident for the State Bank group, foreign banks and old private banks.

Credit-Deposit Ratio

3.27 According to the data available from the Basic Statistical Returns (BSR), the credit-deposit (C-D) ratio of SCBs as at end-March 2002 (as per utilisation) was 58.4 per cent (Appendix Table III.9) The total flow of resources, as reflected in the credit plus investment to deposit (IC-D) ratio showed an increase (as per utilisation) over the last few years. The same trend has been observed in all the regions, except the western region. The western region showed a decline as at end-March 2002 as compared with end-March 2001 mainly due to a decline in the IC-D ratio of Maharashtra, which may be partly attributed to the impact of the merger.

Credit to Government

3.28 Commercial banks continued to invest heavily in Government paper, as the sustained softening of interest rates continued to fuel a rally in gilt prices. As a result, commercial bank SLR investments further increased to 38.5 per cent of their net demand and time liabilities (NDTL) as at end-March 2003 from 36.0 per cent as at end-March 2002, much above the stipulated minimum norm of 25.0 per cent. This climbed to over 40 per cent of NDTL by end-September 2003, amidst surplus liquidity in financial markets.

Role of Banks as Authorised Dealers (ADs)

3.29 A distinctive feature of the 1990s has been the growing influence of capital flows on the operations of the monetary and banking system (Box III.1). Not only has the liberalisation of the external sector significantly enhanced the quantum of funds channeled between residents and nonresidents manifold, but increasingly, the relaxation of balance sheet restrictions in respect of foreign exchange operations has transformed banks into active participants in the foreign exchange markets. Switches in capital flows, therefore, now directly affect bank liquidity. Second, the resultant impact on interest rates has been impacting bank profitability. Third, given the differential between domestic and international interest rates, the allocation between domestic and foreign assets also influences bank profitability, especially in view of the increasing liberalisation of banks' foreign exchange operations. The turnover in the foreign exchange business of banks increased by an annual average of about 4 per cent, in US dollar terms, between 1997-98 and 2002-03. While inter-bank transactions still continue to account for around 80 per cent of the total turnover, the merchant banking business of the ADs has grown much faster in recent years (Table III.8).

Table III.8: Composition of Foreign Exchange Turnover of Authorised Dealers
(Amount in US $ million, ratios in per cent)
Year	Merchant		Inter-Bank		Total
	Purchase	Sale	Purchase	Sale	Purchase	Sale
1	2	3	4	5	6	7
1997-98	97,937	1,11,989	5,58,019	5,38,103	6,55,956	6,50,091
	(14.9)	(17.2)	(85.1)	(82.8)	(100.0)	(100.0)
1998-99	1,18,097	1,34,587	5,40,752	5,34,294	6,58,849	6,68,881
	(17.9)	(20.1)	(82.1)	(79.9)	(100.0)	(100.0)
1999-2000	1,23,747	1,28,294	4,66,042	4,65,844	5,89,789	5,94,139
	(21.0)	(21.6)	(79.0)	(78.4)	(100.0)	(100.0)
2000-01	1,33,214	1,48,018	5,90,638	5,62,379	7,23,852	7,10,397
	(18.4)	(20.8)	(81.6)	(79.2)	(100.0)	(100.0)
2001-02	1,34,966	1,37,420	6,04,678	6,10,295	7,39,644	7,47,715
	(18.2)	(18.4)	(81.8)	(81.6)	(100.0)	(100.0)
2002-03	1,65,544	1,63,664	6,24,151	6,31,380	7,89,695	7,95,044
	(21.0)	(20.6)	(79.0)	(79.4)	(100.0)	(100.0)
Note: Figures in brackets are shares in total turnover.

Box III.1: Banks as Authorised Dealers The Reserve Bank designates specific banks as authorised dealers (ADs) for undertaking various foreign exchange transactions. There are currently 92 banks (inclusive of 35 foreign banks) functioning as ADs through 27,762 branches. The Reserve Bank also authorises companies to transact in foreign exchanges through two other channels, viz., full-fledged money-changers (FFMCs), who are allowed to buy and sell foreign exchange against Indian Rupees, and restricted money changers (RMCs), who can only buy foreign exchange against Indian Rupees. The Reserve Bank also permits ADs and FFMCs to enter into agency/franchising agreements with entities for the purposes of carrying on RMC business subject to certain conditions. In addition, the Reserve Bank authorises certain development finance institutions to undertake specific types of foreign exchange transactions incidental to their main business. The Foreign Exchange Management Act (FEMA), 1999, allows an AD in India or a branch outside India of an Indian bank to lend in foreign currency subject to certain conditions. An AD is allowed to grant loans to its constituents in India, wholly-owned subsidiaries abroad, joint ventures abroad of Indian entities and another AD in India. An AD in India may borrow in foreign currency subject to certain conditions, including its head office or branch or correspondent outside India up to 25 per cent of its unimpaired Tier I capital, or US $ 10 million, whichever is higher. ADs play a crucial role in the development of India's foreign exchange market. In view of the gradual approach to external liberalisation, ADs have been given powers to buy and sell foreign exchange on behalf of their clients by ensuring proper documentation without the intervention of the Reserve Bank, subject to limits deemed sufficient to cover the underlying authorised transactions. For foreign exchange transactions beyond the limits set for specific purposes, however, the permission of the Reserve Bank is required for the release of foreign exchange. For specified current account transactions relating to purposes like education, medical treatment, employment, emigration, family maintenance and private travel, only self-certification is needed. In view of the substantial autonomy in conducting foreign exchange business, ADs have emerged as main agencies responsible for implementation of the FEMA and the notifications under the Act. The Reserve Bank has decided not to specify the documents to be verified by ADs while transacting in foreign exchange. Both ADs and their customers desiring to carry out foreign exchange transactions have the responsibility to ensure that all applicable regulatory requirements and guidelines are being followed in course of their business. The Reserve Bank would mainly focus on the effective monitoring of the operations of ADs, under the liberalised regime. As a result, the inspection approach of the Reserve Bank has shifted from transaction-specific inspection to systems-supervision. ADs are required to report their turnover to the Reserve Bank on a daily basis. The Reserve Bank scrutinises returns submitted by the ADs to ensure effective implementation of the FEMA regulations/ notifications.

International Banking Statistics

3.30 Monitoring of the cross-border flow of funds has assumed critical importance in view of the growing liberalisation of the external sector. The Reserve Bank now compiles and disseminates international banking statistics (IBS) on the lines of the reporting system devised by the Bank for International Settlements (BIS). Such statistics provide an understanding of the total magnitude of international assets and liabilities of the banking system and their composition, mainly in terms of maturity, currency composition and country of residence. International assets / liabilities cover claims / liabilities of reporting banks with / toward nonresidents in any currency and residents only in foreign currency.

3.31 The locational banking statistics (LBS) provide the gross position of international assets and international liabilities of all banking offices located in India. They report exclusively banks' international transactions including the transactions with any of their own branches / subsidiaries /joint ventures located outside India.

3.32 International liabilities of banks recorded a sharp increase during both 2001-02 and 2002-03 partly driven by the accretion to non-resident deposits and their large-scale foreign currency borrowings (Table III.9). International liabilities were predominantly denominated in either US dollars or Indian Rupees, given the large size of Rupee non-resident deposits.

Table III.9: International Liabilities of Banks Classified According to Type
(Rs. crore)
Liability type		Amount outstanding
		as at end-March
		2001	2002	2003
1		2	3	4
1.	Deposits and Loans	1,04,148	1,20,604	1,45,930
	of which:
	Foreign Currency Non-
	Resident Bank [FCNR(B)]
	Scheme	37,991	39,636	43,989
	Foreign Currency
	Borrowings*	1,222	5,514	18,411
	Non-resident External
	Rupee (NRE) Accounts	29,413	33,233	53,124
	Non-Resident Non-
	Repatriable (NRNR) Rupee
	Deposits	25,867	27,181	15,207
2.	Own Issues of Securities
	Bonds (including IMDs/RIBs)	43,652	43,582	44,087
3.	Other Liabilities	4,580	7,150	10,475
	ADRs / GDRs	850	1,862	3,833
	Equities of banks held by
	non-residents	382	547	556
	Capital/remittable profits
	of foreign banks in India
	and other unclassified
	International liabilities	3,348	4,741	6,086
Total International Liabilities		1,52,380	1,71,336	2,00,493
*	Inter-bank borrowing in India and from abroad, external
	Commercial borrowings of banks.

3.33 Banks' international assets, as at end-March 2003, on the other hand, remained roughly the same as at end-March 2002 (Table III.10). There was, however, a dramatic change in the composition of banks' international assets, with a large scale substitution of nostro balances, including term deposits with non-resident banks, with foreign currency loans to residents, reflecting higher domestic demand for relatively cheaper foreign currency loans. The bulk of the international assets continued to be held in US dollars, although the share of Euro persisted to record a steady rise.

Table III.10: International Assets of Banks Classified According to Type
(Rs. crore)
Asset type		Amount outstanding
		as at end-March
		2001	2002	2003
1		2	3	4
1. Loans and Deposits		80,389	95,794	97,657
of which:
Loans to non-residents*		4,397	5,218	4,634
Foreign Currency Loans to
Residents**		13,446	19,561	36,859
Outstanding export bills
Drawn on non-residents by
Residents		11,119	15,190	19,242
Nostro balances@		51,287	55,642	36,708
2. Holdings of debt securities		607	952	1,027
3. Other assets@@		2,237	4,629	5,890
Total International Assets		83,233	1,01,375	1,04,574
*	Includes Rupee loans and Foreign Currency (FC) loans out
	of non-resident deposits.
**	Includes loans out of FCNR (B) deposits, PCFCs, FC lending
	To and FC Deposits with banks in India, etc.
@	Including balances in term deposits with non-resident banks
	(including FCNR funds held abroad).
@@	Capital supplied to and receivable profits from foreign
	branches/subsidiaries of Indian banks and other unclassified
	International assets.

3.34 The consolidated banking statistics (CBS) provide comprehensive and consistent quarterly data on banks' financial claims on other countries, both on immediate borrower basis for providing a measure of country transfer risk, and on ultimate risk basis for assessing country credit risk exposures of the domestic banking system. The immediate country risk refers to the country where the original risk lies and the ultimate country risk relates to the country where the final risk lies. The consolidated claims of banks, based on immediate country risk, as at end-March 2003 were mainly concentrated on the US, Hong Kong and the UK (Table III.11).

Table III.11: Consolidated International Claims of Banks on Countries Other Than India: Amount Outstanding
(based on CBS statement)
(Rs. crore)
Country		Ultimate country risk basis			Immediate country risk basis
		March	September	March	June	September	March
		2001	2001	2002	2002	2002	2003
1		2	3	4	5	6	7
France		1,638	2,445	2,230	2,582	2,599	2,461
		(2.2)	(2.9)	(2.4)	(2.7)	(2.7)	(2.7)
Germany		4,542	4,567	4,078	3,689	3,463	3,281
		(6.1)	(5.4)	(4.4)	(3.9)	(3.6)	(3.6)
Hong Kong		2,025	2,869	3,107	14,317	14,115	13,416
		(2.7)	(3.4)	(3.3)	(15.1)	(14.7)	(14.7)
Italy		2,666	4,623	3,706	3,362	3,362	2,832
		(3.6)	(5.5)	(4.0)	(3.6)	(3.5)	(3.1)
Singapore		1,936	3,239	4,118	6,080	5,976	5,776
		(2.6)	(3.8)	(4.4)	(6.4)	(6.2)	(6.3)
United Kingdom@		7,900	8,599	11,351	12,140	13,500	12,779
		(10.6)	(10.2)	(12.2)	(12.8)	(14.0)	(14.0)
United States of America		30,037	31,704	35,473	20,940	21,607	20,446
		(40.4)	(37.5)	(38.2)	(22.1)	(22.5)	(22.5)
All Other Countries		23,621	26,446	28,762	31,534	31,609	30,070
		(31.8)	(31.3)	(31.0)	(33.3)	(32.8)	(33.0)
Total Consolidated International Claims		74,365	84,492	92,825	94,644	96,231	91,061
(including claims on India)		(100.0)	(100.0)	(100.0)	(100.0)	(100.0)	(100.0)
@ excluding Guernsey, Isle of Man and Jersey.
Notes:	1. Figures in brackets are percentages to total.
	2. The country-wise CBS has been compiled based on country of ultimate risk till March 2002. The data from the quarter ended June 2002 onwards, adopt country of immediate risk-based classification. Hence, the data for March 2003 are not strictly comparable with those of earlier years/quarters.

3.35 The distribution of consolidated international claims of banks on various countries, other than India, according to residual maturity reveals that banks continue to prefer to invest/lend for short-term purposes although there was a slight shift to longer-term maturities during the year (Table III.12).

Table III.12: Maturity (Residual) Classification of Consolidated International Claims of Banks: Amount Outstanding
(based on CBS statement)
(Rs. crore)
Country			Ultimate country risk basis			Immediate country risk basis
			March 2001	September 2001	March 2002	June 2002	September 2002	March 2003
1			2	3	4	5	6	7
Up to 6 months			35,679	52,572	70,879	61,842	63,285	59,831
			(48.0)	(62.2)	(76.4)	(65.3)	(65.8)	(65.7)
6 months - 1 year			2,105	3,830	4,401	10,502	7,245	6,412
			(2.8)	(4.5)	(4.7)	(11.1)	(7.5)	(7.0)
1 year - 2 years			971	2,213	3,674	3,916	4,887	4,247
			(1.3)	(2.6)	(4.0)	(4.1)	(5.1)	(4.7)
Over 2 years			7,683	8,213	9,224	14,197	18,895	18,861
			(10.3)	(9.7)	(9.9)	(15.0)	(19.6)	(20.7)
Unallocated			27,927	17,664	4,647	4,185	1,919	1,710
			(37.6)	(20.9)	(5.0)	(4.4)	(2.0)	(1.9)
Total			74,365	84,492	92,825	94,644	96,231	91,061
			(100.0)	(100.0)	(100.0)	(100.0)	(100.0)	(100.0)
Notes:	1.	Unallocated residual maturity comprises maturity not applicable (e.g., equities) and maturity information not available from reporting bank branches.
	2.	Figures in brackets are percentages to total.
	3.	The country-wise CBS has been compiled based on country of ultimate risk till March 2002. The data from the quarter ended June 2002 onwards, adopt country of immediate risk-based classification. Hence, the data for March 2003 are not strictly comparable with those of earlier years/quarters.

3.36 The contours of the management of liquidity by commercial banks during 2002-03 were different from that of 2001-02, essentially because of a revival of credit demand with a turnaround in industrial activity. The analysis of banks' liquidity management is facilitated by the compilation of the Commercial Bank Survey following the recommendations of the Working Group on Money Supply: Analytics and Methodology of Compilation (Chairman: Dr. Y. V. Reddy) (Box III.2, Table III.13 and Appendix Table III.10).

3.37 Portfolio management by banks, reinforced by the Reserve Bank's simultaneous operations in the foreign exchange and Government securities markets, allowed a smooth reallocation of domestic and foreign asset flows during 2002-03 (Chart III.4). Besides, the announcement of indicative calendars for the auctions of the Central Government dated securities as well as Treasury bills during 2002-03 provided greater manoeuvrability to banks to plan their investments and manage their liquidity⁴. The availability of surplus liquidity with the banking system ensured the continuation of a regime of softening interest rates, even while funding the higher demand for credit (Chart III.5). The higher credit off-take during 2002-03 was, by and large, funded by a redeployment of assets - essentially a liquidation of both domestic and foreign investments built up in the previous phase of easy liquidity so that there was no need for banks to either canvass for deposits or cut down their exposures in gilts - without putting immediate pressure on interest rates. The share of deposit mobilisation in the sources of funds declined to 91.7 per cent, net of merger effects, during 2002-03 from 96.6 per cent during the previous year. The resultant gap was funded by a mix of higher call/term funding from financial institutions, overseas foreign currency borrowings and drawdown of foreign currency assets. In contrast to 2001-02, when banks parked a sizeable portion of the liquidity emanating from foreign currency flows in foreign assets because of a lack of domestic demand, they preferred, during 2002-03, to liquidate such investments to advance loans in foreign currency to domestic corporates.

Chart III.4: Movements in Net Demestic Assets and Net Foreign Currency Assets of the Banking Sector

Box III.2: Commercial Bank Survey The Reserve Bank publishes an analytical Commercial Bank Survey of commercial banks’ assets and liabilities, following the recommendations of the Working Group on Money Supply: Analytics and Methodology of Compilation (Chairman: Dr. Y. V. Reddy). The Commercial Bank Survey draws not only on the Form A submitted by banks under Section 42(2) of the Reserve Bank of India Act, 1934, which has been the traditional source of fortnightly data on commercial banks, but also on the Memorandum and Annexures A and B appended to Form A on the recommendations of the Reddy Working Group. This allows it to capture three critical changes taking place in the bank balance sheets in the light of financial sector reforms: Broadening of the concept of bank credit from the conventional credit (in the form of loans, cash credit, overdrafts and bills purchased and discounted) to include investments in non-SLR money market and capital market instruments. Composition of net foreign assets of commercial banks, comprising their holdings of foreign currency assets, netted for non-resident repatriable foreign currency fixed deposits. Consequently, bank deposits are adjusted for these non-resident deposits to arrive at deposits of residents. Introduction of a capital account, comprising capital and reserves. The gradual firming up of the reporting system for commercial banks set up on the basis of the Reddy Working Group report increasingly provides a comprehensive view of the intra-year flow of funds within the financial system. The enhanced coverage in the CBS has narrowed down the gap between identified liabilities and assets in commercial bank data to about Rs.6,000 crore (0.5 per cent of deposits) from about Rs.84,000 crore (6.6 per cent of deposits) in Form A as at end-March 2003. References: Reserve Bank of India (1998), Report of the Working Group on Money Supply: Analytics and Methodology of Compilation (Chairman: Dr. Y. V. Reddy), Mumbai. Reserve Bank of India (2000), "New Monetary Aggregates", Reserve Bank of India Bulletin, Mumbai. Reserve Bank of India (2003), Annual Report, Mumbai.

Table III.13: Operations of Scheduled Commercial Banks
(Rs. crore)
Variable				Outstanding	2002-03				2001-02
				as on
				March 21, 2003	Q4	Q3	Q2	Q1	Q4	Q3	Q2	Q1
	1			2	3	4	5	6	7	8	9	10
I.	Components
Aggregate Deposits of Residents 11,58,942					24,073	37,484	32,201	52,675	32,122	29,675	20,856	53,337
	Demand Deposits			1,70,289	5,405	11,654	-4,535	4,717	4,412	10,074	-9,382	5,392
	Time Deposits of Residents			9,88,653	18,668	25,829	36,735	47,958	27,710	19,601	30,237	47,945
Call/Term Funding from
Financial Institutions				12,638	2,142	227	792	6,448	-1,471	409	1,865	-341
II.	Sources
Credit to the Government				5,23,417	23,798	22,680	18,716	47,047	12,049	13,791	21,088	24,213
Credit to the Commercial Sector				8,46,494	27,881	39,481	20,322	22,825	33,676	31,320	11,217	9,349
	Food Credit			49,479	-2,468	-1,415	-7,645	7,030	1,702	4,015	-2,079	10,349
	Non-food Credit			6,35,192	39,439	32,541	19,945	7,522	28,347	25,673	12,649	-2,367
	Net Credit to Primary Dealers			4,093	-5,886	959	5,817	2,874	526	115	-401	221
	Investments in Other Approved Securities			24,129	-306	-965	-459	-1,233	-644	-1,452	62	-997
	Other Investments (in non-SLR Securities)			1,33,601	-2,898	8,361	2,664	6,633	3,745	2,970	986	2,143
Net Foreign Currency Assets
of Commercial Banks				-68,366	-8,820	-9,027	-15,136	2,748	-2,670	-3,544	-941	4,952
	Foreign Currency Assets			31,082	-5,345	-7,955	-14,412	4,718	-3,483	-1,996	2,023	5,886
	Non-resident Foreign Currency
	Repatriable Fixed Deposits			92,240	-703	-230	669	1,655	475	1,425	2,018	835
	Overseas Foreign Currency Borrowings			7,208	4,178	1,302	55	315	-1,288	123	946	99
Net Bank Reserves				65,823	-5,700	-1,619	11,055	-2,943	-3,929	-1,277	-7,373	16,304
Capital Account				86,541	1,625	-1,815	-742	15,152	1,150	958	2,297	4,403
Memo:
Release of resources through changes in CRR				-	0	3,500	0	6,500	0	8,000	0	4,500
Net open market sales to commercial banks				-	7,338	12,803	13,228	3,131	0	1,904	9,614	4,106
Notes:		1. Q1 refers to the quarter ending June, and so on.
		2. Deposits have been adjusted for the full impact of the mergers while credit has been adjusted for the initial impact of the same since May 3, 2002.

3.38 The portfolio allocation of banks' foreign currencies has several macro and monetary implications. If banks choose to park balances abroad, the entire transaction set is money -and output-neutral. If banks advance loans in foreign currency to residents, the transaction set is money-neutral because funds are still deployed abroad but there is an output effect arising out of the funds received by domestic industry. If banks convert their foreign currencies with the Reserve Bank in Rupees and advance loans to domestic corporates, there is a monetary as well as an output effect. If domestic corporates convert their foreign currency loans to meet domestic expenditure, the monetary impact depends on whether the banking system is able to meet this demand through a substitution within its existing portfolio or whether it accesses the Reserve Bank for Rupee resources. Since such exchange rate risk is borne by the domestic corporates, the Mid-term Review of the Monetary and Credit Policy of November 2003, requires banks to extend foreign currency loans above US $ 10 million only on the basis of a well-laid out policy by each bank to ensure hedging, except in case of exports receivables and for meeting foreign exchange expenditures.

3.39 Fiscal 2002-03 commenced with the usual ample liquidity conditions during April, thereby unwinding the end-of-the-year tightening in the market for funds. This was counter-balanced by the commencement of the market borrowing programme of the Central Government, reinforced by the Reserve Bank's open market (including repo) purchases. Liquidity conditions, in fact, tightened in the first half of May, as the Government's market borrowing programme progressed and with a substantial pick up in food credit. This led to a withdrawal of banks from LAF auctions and a drawdown of their balances with the Reserve Bank. Furthermore, border tensions created market uncertainty, necessitating a series of private placements of the Government securities with the Reserve Bank during the second half of May. The reduction of CRR by 50 basis points, reinforced by Government bond redemptions, augmented liquidity conditions in June, facilitating banks' subscriptions in the auctions of Government securities and advance tax outflows. The repo rate reduction of 25 basis points on June 27 restored sentiments and regenerated interest in the Government securities market.

3.40 There was a sharp increase in non-food credit off-take during the remaining part of the year, engendered by the turnaround in industrial activity. Besides the liquidity injected by a CRR cut of 25 basis points in November, this was, by and large, funded by a deployment of assets through the following means, viz., (a) a decline in food credit, as a result of drought conditions, (b) a drawdown of nostro balances (especially to meet foreign currency credit demand), (c) reduced subscriptions in the LAF repo auctions, and (d) liquidation of non-SLR investments. As a result, ample liquidity conditions continued to prevail, notwithstanding a few stray episodes of temporary tightness, viz., around mid-November (gilt auction outflows before transiting to a higher average daily CRR maintenance), in mid-January (sizeable open market sales) and the latter part of February (on-tap sales of State Governments loans). The impact of capital flows on bank liquidity was neutralised as the Reserve Bank continued to counterbalance its purchases of foreign currency with open market sales of Government securities even as the tempo of Government's market borrowing moderated. The ample liquidity facilitated a smooth phasing out of the collateralised lending support facility to banks by the Reserve Bank effective from the fortnight beginning October 5, 2002. The year 2003-04 so far was also characterised by easy liquidity emanating predominantly from a continued upsurge in capital inflows which more than counterbalanced the deceleration in commercial banks’ domestic deposit mobilisation and relatively moderate credit demand. A reduction in the CRR by 25 basis points to 4.5 per cent of NDTL in June 2003 also released additional funds to the banking system. Mirroring easy liquidity conditions, the repo rate was cut by 50 basis points to 4.5 per cent in August 2003. As a consequence, commercial banks’ investments in the Government securities remained strong through primary auctions and open market (including repo) operations.