2.   Financial Sector Reform Measures

A.  Interest  Rate  Deregulation

1.5     Interest rates in India were further deregulated during 1997-98.  The minimum period of maturity of term deposits was reduced from 30 days to 15 days in April 1998 and interest rates on them too have been deregulated.  Interest rates on small loans up to Rs.2 lakh each, were not to exceed the lending rates that are applicable to the prime borrowers in the category of over Rs.2 lakh.  During 1997-98 and 1998-99 so far, the Bank Rate was utilised as a signalling mechanism for influencing the direction of interest rate movements in the economy.

Bank Rate

1.6  In the context of slowdown in industrial production, the Bank Rate was reduced by one percentage point to 11.0 per cent per annum' with effect from April 16, 1997.   Further, the interest rates on accommodation from the Reserve Bank which were hitherto not related to the Bank Rate were linked to it.  In view of the limited offtake of bank credit and in the light of the prevalence of sufficient liquidity, the Bank Rate was reduced further from 11.0 per cent per annum to 9.0 per cent per annum', in two stages, by one percentage point each with effect from June 26, 1997 and October 22, 1997, respectively.  However, on account of the volatility in the foreign exchange market, with effect from the close of business on January 16, 1998, the Bank Rate was increased by two percentage points, i.e., from  9.0 per cent per annum to 11.0 per cent per annum'. On a review of the monetary and credit situation and in view of the onset of orderly conditions in the foreign exchange market, the increase in the Bank Rate was partially rolled back  to 10.0 per cent per annum' with the reduction in two steps of one half of one percentage point each with effect from the close of business on March 18 and April 2, 1998, respectively. The Bank Rate was further reduced by one percentage point to 9.0 per cent per annum' effective from April 29, 1998, thus restoring the rate to the level  prevailing before January 17, 1998.

Domestic Term Deposits

1.7  The ceiling on interest rate on domestic term deposits for maturity of 30 days and upto one year was linked to the Bank Rate and accordingly was reduced from the then existing 10.0 per cent per annum to the Bank Rate minus two percentage points per annum (i.e. 9.0 per cent)  with effect from April 16, 1997. Effective June 26, 1997, the ceiling on interest rate was reduced to 8.0 per cent per annum from the earlier 9.0 per cent per annum consistent with the reduction in the Bank Rate.

1.8  With a view to giving banks full freedom to determine the interest rates on term deposits of different maturities, effective October 22, 1997, interest rates on domestic term deposits of 30 days and above were deregulated.  Banks, however, could determine the rates only after obtaining prior approval from their respective Boards.

1.9  The Monetary and Credit Policy announced on April 29, 1998 covered various measures aimed at providing greater freedom to banks in respect of several aspects of their deposit/lending operations.  The minimum period of maturity of term deposits was reduced from 30 days to 15 days. Banks were permitted to determine their own penal interest rates for premature withdrawal of domestic term deposits and banks were advised to ensure that depositors are made aware of the applicable penal rate along with the deposit rate. Restriction on banks that they must offer the same rate on deposits of the same maturity irrespective of the size of such deposits was removed for domestic term deposits of Rs.15 lakh and above. Banks should, however, disclose in advance the schedule of interest rates payable on deposits including deposits on which differential interest rates would be paid and the rates are not  subject to negotiation between the depositor and the bank.  The Boards of banks are required to lay down policy in this regard.

Deposits under Non-Resident (External) (NRE)  Rupee Accounts Scheme

1.10  In line with the changes effected in the prescription of interest rates on domestic term deposits, the interest rates on term deposits under Non-resident (External) Rupee Accounts (NRE) Scheme of over one year were freed with effect from April 16, 1997  and were brought on par with those on domestic term deposits.  The ceiling on interest rate was reduced by three percentage points from 12.0 per cent per annum to Bank Rate minus 2 percentage points per annum (i.e. 9.0 per cent) on maturity of 6 months and upto one year.  The ceiling interest rate was further reduced to 8.0 per cent from 9.0 per cent, effective June 26, 1997.  Effective September 13, 1997, banks were given freedom to fix their own interest rates on NRE term deposits of six months and over.  On April 29, 1998, as in the case of FCNR(B) deposits, banks were permitted to determine their own penal interest rates for premature withdrawal of NRE deposits and depositors would need to be informed of the applicable penal rate. Further, banks were permitted to fix their own overdue interest rates in respect of NRE deposits remaining overdue for period exceeding 14 days, subject to these deposits being renewed.

Interest Rates on Deposits under Foreign Currency Non-Resident Accounts (Banks) [FCNR(B)]  Scheme

1.11  Freedom was given to banks to determine their own rates on deposits under the Foreign Currency Non-Resident (Banks) [FCNR(B)] Scheme subject to ceilings prescribed by the Reserve Bank from time to time, effective April 16, 1997.  Effective October 22, 1997, the ceiling rates were prescribed at the relevant London Interbank Offered Rate (LIBOR) prevailing on the last working day of the previous week for relevant maturity and currency, in respect of deposits of six months and above but less than one year and floating rate deposits. In respect of deposits of maturity of one year and above, the interest would be within the ceiling of swap rates for the respective currencies/maturities.  Subject to the above, banks are free to offer either fixed or floating rate of interest on such deposits.

1.12  Taking into account the international developments which  pointed to the problems relating to short-term external liabilities and large unhedged positions of corporates in some of the South East Asian countries, banks were encouraged to mobilise  longer-term, rather than short-term deposits.  Accordingly, on April 29, 1998, the interest rate ceiling on FCNR(B) deposits of one year  and above was increased by 50 basis points and that on such deposits below one year and floating rate deposits was reduced by 25 basis points.  Further, banks were permitted to fix their own overdue interest rates in respect of FCNR(B) deposits remaining overdue for periods exceeding 14 days, subject to these deposits being renewed.

Lending Rates

1.13  As a part of the process of deregulating interest rates on credit limits  up to Rs.2 lakh and in view of the movements in the interest rates, effective October 22, 1997, the lending rate prescription for credit limits of over Rs.25,000 and up to Rs.2 lakh, was changed from a fixed rate of 13.5 per cent to a ceiling prescription of not exceeding 13.5 per cent'.

In order to remove the disincentive to the flow of credit to small borrowers, effective April 29, 1998, the interest rates on loans upto Rs.2 lakh were not to exceed the prime lending rate (PLR) which is the rate available to the prime borrowers with credit limits of over Rs.2 lakhs of the concerned bank.

Prime Term Lending Rate

1.14  With a view to giving banks more freedom to determine the interest rates,   banks were allowed in October 1997 to prescribe separate Prime Term Lending Rates (PTLRs) with approval of their Boards, for term loans of 3 years and above, apart from the freedom to fix separate  PLRs for cash credit and loan components given earlier.

Housing Finance Intermediary Agencies

1.15  The stipulation that banks should extend finance to housing finance intermediary agencies for onlending at 1.5 percentage points below PLR was withdrawn and effective October 22, 1997, banks were given freedom to charge different interest rates provided these are below each bank's PLR.

Advances against Term Deposits

1.16  It was announced on April 29, 1998 that all advances against term deposits would be at interest rates equal to PLR or less.

Loans against FCNR(B) Deposits and Loans out of  FCNR(B) Pools

1.17  As a matter of rationalisation, multiple prescriptions linked to loans against FCNR(B) deposits and loans out of FCNR(B) pools and loans against foreign currency were dispensed with, effective October 21, 1997 and banks were given freedom in relation to uses and rates as available in the case of advances in general.

Bank Credit for Imports

1.18  In the context of developments in the foreign exchange market, an interest rate surcharge of 15.0 per cent of the lending rate was imposed on bank credit for imports with effect from December 18, 1997, which  was further enhanced to 30.0 per cent, effective January 17, 1998.

B.     Measures Relating to Reserve Requirements

Cash Reserve Ratio (CRR) on Domestic Term Deposits

1.19  With a view to facilitating the development of  a more realistic rupee yield curve and term money  market, liabilities  of all  SCBs [excluding  Regional Rural Banks (RRBs)] to banking system were exempted from the requirement of Cash Reserve Ratio  (CRR) with effect from the fortnight beginning April 26, 1997,  releasing an amount of Rs.950 crore of resources of banks.

1.20  In accordance with the stance of phased reduction in statutory pre-emption of banks' resources, Monetary and Credit Policy during the second half of 1997-98 announced reduction in the CRR to be maintained by SCBs (excluding RRBs) by 2.0 percentage points from 10.0 per cent of Net Demand and Time Liabilities (NDTL) to 8.0 per cent in eight phases of 0.25 percentage point each with effect from the fortnights beginning October 25, 1997, November 22, 1997, December 20, 1997, January 17, 1998, February 14, 1998, February 28, 1998, March 14, 1998 and March 28, 1998. As a result of a two percentage points reduction in CRR, the resources of banks were estimated to be augmented by about Rs.9,600 crore (Rs.1,200 crore for each phase of reduction).  It was indicated in the policy announcement that giving effect to the reduction in CRR during the months of February and March, 1998 would, however, be contingent on the monetary and price situation at that time.

1.21  Taking into account the overall liquidity position and the developments in the financial markets, in particular, the possible spill-over effects on the foreign exchange markets, the envisaged reductions in CRR was deferred from the fortnight beginning December 20, 1997, and the phasing  of CRR reductions was to be made effective from fortnights beginning January 31, 1998 upto April 11, 1998.  However, in view of the situation prevailing in financial and foreign exchange markets, effective from the fortnight beginning December 6, 1997, the CRR to be maintained by SCBs (excluding RRBs)  was increased by one half of one percentage point from 9.5 per cent to 10.0 per cent.   The schedule of reductions in CRR announced on November 28, 1997 was kept in abeyance. On a review of the monetary and credit situation and in view of then prevailing  volatility in the foreign exchange market, as a part of the package of measures announced on January 16, 1998, the CRR to be maintained by SCBs (excluding RRBs) was increased by one-half of one percentage point from 10.0 per cent to 10.5 per cent of NDTL, effective from the fortnight beginning January 17, 1998.   As a result, the resources of SCBs were impounded to the extent of Rs.2,500 crore.  This measure was rolled back subsequently.   The CRR to be maintained by SCBs (excluding RRBs) was reduced by 0.5 percentage point from 10.5 per cent to 10.0 per cent in two phases of 0.25 percentage point each with effect from the fortnight beginning March 28, 1998 and April 11, 1998.  In view of the re-emergence of volatile condition in the foreign exchange market, the Reserve Bank increased CRR from 10.0 per cent to 11.0 per cent, effective from August 29, 1998.

Release of Impounded Cash Balances

1.22  In the light of the then foreign exchange situation and the consequent need to contain overall demand by moderating monetary expansion, effective  May 4, 1991, banks were required to maintain incremental CRR of 10.0 per cent  on the increase in NDTL over the level as on May 3, 1991.  Banks were exempted from the maintenance of the 10.0 per cent incremental CRR for any increase in NDTL over the level as on April 17, 1992 but the balances remained impounded.  One-third of the amount impounded between May 4, 1991 and April 17, 1992 was subsequently released in three equal instalments in October 1992.

1.23  In May 1998 it was decided to release  the remaining two-third balances impounded during the period from May 4, 1991 and April 17, 1992.  These balances would be released in twelve equal monthly instalments from the fortnight beginning May 23, 1998 and extending upto March 13, 1999.  Six instalments have been released so far, upto September 26, 1998.

CRR on Deposits under NRE, NRNR and FCNR(B) Schemes

1.24  Simultaneous with freeing the reserve requirements on liabilities to the banking system in April 1997 and with a view to bringing all liabilities to the public under the umbrella of reserve requirements, with effect from the fortnight beginning April 26, 1997, a CRR of 10.0 per cent on the increase in liabilities under Foreign Currency Non-Resident Accounts (Banks)  [FCNR(B)] scheme, Non-Resident Non-Repatriable Rupee (NRNR) Accounts scheme and Non-Resident (External) Rupee (NRE) Accounts Scheme over the level outstanding as on April 11, 1997 was imposed.  These liabilities were  subject to zero CRR prescriptions at that time.

1.25  Subsequently, from the fortnight beginning December 6, 1997, the liabilities under NRE Accounts and NRNR Accounts were exempted from maintenance of incremental CRR of 10.0 per cent. The amount thus impounded under 10.0 per cent incremental CRR upto December 5, 1997 under NRE Accounts and NRNR Accounts was released on December 6, 1997.  However, the CRR prescription in respect of  FCNR(B) Scheme was left unchanged.

Interest on Cash Balances Maintained with the Reserve Bank under CRR

1.26  All SCBs (excluding RRBs) were paid interest on eligible cash balances maintained with the Reserve Bank under the CRR requirements according to a two-tier formula. Under the two-tier formula, interest was paid at the rate of 10.5 per cent per annum on eligible cash balances based on NDTL outstanding as on March 23, 1990, and no interest was paid on the increase in the eligible cash balances (based on the increase in NDTL over the level as on March 23, 1990), maintained with the Reserve Bank.  The effective rate of interest on the entire eligible cash balances worked out to about 3.5 per cent.  With a view to rationalising the system of payment of interest on eligible CRR balances, with effect from the fortnight beginning October 25, 1997, banks would be paid interest at the rate of 4.0 per cent per annum on all eligible cash balances maintained with the Reserve Bank under the Reserve Bank of India Act, 1934. This had the effect of improving the return on such balances since the revised rate would be applicable on the entire eligible cash balances.

Statutory Liquidity Ratio

1.27  Effective the fortnight beginning April 26,1997, liabilities to the banking system were also exempted from maintenance of Statutory Liquidity Ratio (SLR) in  line with the exemption for CRR requirements. With a view to rationalising the prescription of SLR, simplify the multiple prescriptions  into a single prescription, with effect from fortnight beginning October 25, 1997, all SCBs were required to maintain a uniform statutory liquidity ratio of 25 per cent on their entire NDTL which is the minimum stipulated under Section 24 of the Banking Regulation Act, 1949.

C.  Measures Relating to Export Credit

1.28  With a view to providing export credit at internationally competitive rates to exporters, a number of measures were announced. There was an overall decline in the interest rates charged on both pre-shipment and post-shipment credit in 1997-98 and thereafter in the current year so far  (Table 1.1).  In August 1998, post-shipment credit upto 90 days and pre-shipment credit upto 180 days were made available to exporters at 9 per cent per annum, which is equal to the Bank Rate in existence.

D.  Measures Relating to Refinance

Export Credit Refinance

1.29  As a move towards further rationalisation of export credit refinance to banks and in the context of introduction of a new General Refinance facility, with effect from the fortnight beginning April 26, 1997, SCBs were provided export credit refinance only on the basis of their incremental export credit, i.e., equivalent to 100 per cent of the increase in outstanding export credit eligible for refinance over the level of such credit as on February 16, 1996.  With a view to enabling the Bank Rate to emerge as a reference rate, the rates of interest on the Reserve Bank refinance facilities were linked to the Bank Rate since April  1997.  Accordingly, the interest rate on refinance was modified along with the changes in the Bank Rate. As a temporary measure, refinance rate was fixed at 2 percentage points below the Bank Rate i.e. 7.0 per cent per annum with effect from August 6, 1998. This revision would be applicable upto March 31, 1999.

1.30  On a review of the monetary and foreign exchange situation then prevailing in the country and also taking into account the international developments, effective from the fortnight beginning January 17, 1998, banks were provided export credit refinance to the extent of 50 per cent of the increase in outstanding export credit eligible for refinance over the level of such credit as on February 16, 1996. After reviewing the changed situation, it was decided to restore the export credit refinance limits of banks to the level of 100 per cent of the incremental export credit eligible for refinance, effective the fortnight beginning May 9, 1998.

General Refinance

1.31  In the context of a move from sector-specific refinance facilities to a general refinance facility, and to enable the Bank Rate to emerge as a reference rate as also to enable banks to tide over their temporary liquidity shortages, effective from the fortnight beginning April 26, 1997, SCBs (excluding RRBs) were provided General Refinance equivalent to 1.0 per cent of each bank's fortnightly average outstanding aggregate deposits of 1996-97. The facility would be provided for two blocks of four weeks each.  The interest rate would be at the Bank Rate for the first four weeks and at the Bank Rate plus one percentage point' for the second block of four weeks.  Banks availing of the facility for eight weeks would face automatic debiting of their accounts with the Reserve Bank.  Banks can avail of this refinance facility afresh if there is a gap of 2 weeks during which there is no borrowing under this facility.  The entitlement to the banking system under this facility was of the order of Rs.4,460 crore.

1.32  In view of the situation in the domestic foreign exchange market and international developments, effective from the fortnight beginning January 17, 1998, this refinance was reduced to 0.25 per cent of each bank's fortnightly average outstanding aggregate deposits in 1996-97.

E.  Measures Relating to the Money Market

Certificates of Deposit

1.33  In April 1997 the minimum size of the issue of Certificates of Deposit (CDs) to a single investor was reduced from Rs.25 lakh to Rs.10 lakh, in multiples of Rs.5 lakh and further reduced to Rs 5 lakh, in multiples of Rs. 1 lakh in October 1997. With effect from May 9, 1998, the minimum lock-in period for CDs was reduced from 30 days to 15 days.

Money Market Mutual Funds

1.34  Prior to October 1997, the resources mobilised by Money Market Mutual Funds (MMMFs) were required to be invested exclusively in call/notice money, CDs, Commercial Papers (CPs), commercial bills arising out of genuine trade/commercial transactions and Treasury Bills and Government dated securities having an unexpired maturity upto one year.  

1.35  With a view to making the scheme of MMMF more flexible, MMMFs were permitted to invest also in rated corporate bonds and debentures with a residual maturity of upto one year. However, the prudential measure that the exposure of MMMFs to CP issued by an individual company should not exceed 3.0 per cent of the resources of the MMMF would continue, with the ceiling of 3.0 per cent  to include bonds and debentures as well.  With effect from May 9, 1998, the minimum lock-in period for units of MMMFs was reduced from 30 days to 15 days.

Routing of Transactions through DFHI

1.36  In April 1991, due to liberalisation of policy relating to participation in the call/notice money market, certain entities were given access to it as lenders with certain  restrictions including the provision that the transaction  should be routed through the Discount and Finance House of India (DFHI).  With effect from the fortnight beginning April 26, 1997, the facility of routing such transactions was extended to all primary dealers(PDs). The minimum size of a transaction  was reduced from Rs.20 crore to Rs.10 crore in April 1997.  This was further reduced to Rs.5 crore in October 1997 and to Rs.3 crore with effect from May 9, 1998.

Other Measures

1.37  In the mid-term review of Monetary and Credit Policy for 1998-99, the following measures were announced:

F.  Improving Credit Delivery System

Loan System for Delivery of Bank Credit

1.38  As a measure of imparting an element of discipline in the utilisation of bank credit, the percentage of loan component' in the working capital credit limit had been enhanced in stages for borrowers with working capital credit limits of (a) Rs. 10 crore or above and less than Rs. 20 crore and (b) Rs. 20 crore and above.  With effect from October 22, 1997, the loan component' level has been made uniform at 80 per cent for the above categories of borrowers.

Bill Finance for Settlement of dues of SSI Suppliers

1.39  With a view to ensuring prompt settlement of dues of Small Scale Industrial (SSI) units and also for encouraging bill culture, banks were advised to ensure that with effect from January 1, 1998, of the total inland credit purchases of the borrowers, not less than 25 per cent should be through bills drawn on them by the concerned sellers.

Bridge Loans

1.40  Banks have been permitted on October 21, 1997 to sanction bridge loans to companies against expected equity flows/issues.  As a prudential measure, it has been stipulated that such bridge loans should not exceed one year and should be accommodated within the ceiling of 5 per cent of incremental deposits of the previous year prescribed for individual bank's investment in shares/convertible debentures.

3. Government Securities Market

Primary Dealers

1.41  The Primary Dealers' (PDs) presence in Government securities market has brought in an element of dynamism, both in primary and secondary markets.  It may be recalled that in pursuance of the Guidelines for PDs in the Government Securities Market' issued by the Reserve Bank on March 29, 1995, approval has been given to six entities, viz., Discount & Finance House of India (DFHI), Securities Trading Corporation of India (STCI), I-Sec, subsidiary of State Bank of India (SBI) - "SBI Gilts Ltd.", subsidiary of Punjab National Bank (PNB)- "PNB Gilts Ltd".  and subsidiary of Canara Bank set up jointly with Bank of Baroda and Corporation Bank - "Gilts Securities Trading Corporation Ltd".   While DFHI and STCI became operational effective March 1, 1996, the other four entities commenced their operations from June 1, 1996. Furthermore, on October 29, 1998 in principle approval has been granted to seven entities, viz., DSP Merrill Lynch, Kotak Mahindra Capital Company (unlimited), Ceat Financial Services Ltd., Tata Finance Securities Ltd., J.P. Morgan Securities India Private Ltd., ABN-Amro Bank (Subsidiary) and Deutche Bank (Subsidiary) to be accredited as PDs in the Government securities market.

Incentives to PDs

1.42  It may be recalled that with a view to providing incentives to PDs to develop the secondary market in Government securities, the Reserve Bank was paying commission on their primary purchases (including the devolvement) of Central Government securities, effective July 10, 1996.  This scheme was, however, later replaced in June 1997 by a  Scheme for Payment of Underwriting Fee to PDs', whereby a minimum of 25 per cent of each issue of Government of India dated securities and Treasury Bills would be offered for underwriting by PDs and the underwriting amount and fee would be determined on the basis of bids submitted and accepted by the Reserve Bank.  This scheme also replaced the system of commiting the PDs' devolvement percentages. The underwriting scheme of PDs is under constant review to make it more efficient and effective as an instrument for primary sales of securities.  On a review, the Scheme of Payment of Underwriting Fee to PDs' was modified in August 1998, as follows :

Liquidity Support to PDs

1.43  PDs in Government securities market have been provided liquidity support through repos operations in 91-day, 364-day auction Treasury Bills and Central Government dated securities at the Bank Rate.  On January 16, 1998 due to volatility in the foreign exchange market, the Reserve Bank announced that PDs in Government securities market will have access to liquidity support on a discretionary basis, subject to the Reserve Bank stipulations relating to their operations in the call money market.  The Monetary and Credit Policy for the first half of the 1998-99 has announced that the practice of reverse repos with PDs in specified securities is being dispensed with and instead liquidity support against the security of holdings in Subsidiary General Ledger (SGL) Accounts will be provided. Accordingly in September 1998, it has been decided that liquidity support to PDs will henceforth be provided by way of demand loan against the security of their holdings in SGL accounts. Advances will be granted against the collateral of holdings of Government of India  dated securities and 91/364- day auction Treasury Bills in SGL accounts maintained with the Reserve Bank.

Routing of Transactions through PDs

1.44  In pursuance of the Monetary and Credit Policy for the second half of the year 1997-98, effective October 22, 1997, the minimum lending limit for entities permitted to access call/notice money market as lenders who route their transactions through PDs was reduced from Rs.10 crore to Rs.5 crore.  This limit was further reduced from Rs.5 crore to Rs.3 crore with effect from May 9, 1998.

Satellite Dealers

1.45  It may be recalled that on December 31, 1996, the Reserve Bank announced the guidelines for Satellite Dealers (SDs) in Government securities market.  The SDs are intended to act as second tier in trading and distribution of Government securities.  The Reserve Bank has already granted approval to nine entities for registration as SDs as on November 18, 1997, viz., 1) DSP Merrill Lynch Ltd., 2) Ceat Financial Services Ltd., 3) Kotak Mahindra Capital Company, 4) Birla Global Finance Co. Ltd., 5) Hoare Govett (India) Securities Ltd., 6) Dil Vikas Finance Ltd., 7) SREI International Securities Ltd., 8) Tower Capital and Securities Pvt. Ltd. and 9) Tata Finance Securities  Pvt. Ltd.

1.46  Reserve Bank has also granted in principle' approval on November 18,  1997 to two banks viz., Bank of America and Bank of Madura Ltd. to be accredited as SDs in the Government securities market.  The banks would be setting up separate units dedicated to the securities business and in particular, the Government securities market.

Ongoing Process of Enlistment/Registration of PDs/SDs

1.47  The schemes of both PDs and SDs have been placed on an ongoing basis and institutions satisfying the eligibility criteria could approach the Reserve Bank from time to time for enlistment/registration as PDs/SDs.

Liquidity Support to SDs

1.48  Liquidity support through reverse repos transactions with the Reserve Bank in Central Government dated securities and auction Treasury Bills up to 50 per cent of the outstanding stocks (face value) thereof at the end of the previous working day has been extended to SDs, effective December 24, 1997.

Ready Forward Transactions

1.49  The SDs have also been extended the facility of ready forward transactions since March 18, 1998.

Issue of Commercial Paper by SDs

1.50  Effective June 17, 1998, SDs in Government securities market have been permitted access to short-term borrowing by issuance of commercial paper.  The eligibility for issuance of commercial paper by SDs which thereby raises deposits are as follows:

Developments in Treasury Bills Market

Bills of varied maturities

1.51  With a view to developing the Treasury Bills market further and providing investors with financial instruments of varying short-term maturities and to facilitate the cash management requirement of various segments of the economy, it was decided in April 1997 to issue Treasury Bills of varied maturities.  Accordingly, the auction of 14-day Treasury Bills on a weekly basis was introduced from June 6, 1997.  The Monetary and Credit Policy for the second half of the year 1997-98 announced the introduction of 28-day Treasury Bills on auction basis.  In the Monetary and Credit Policy measure announced for the first half of the year 1998-99,  it was further decided to reintroduce 182- day Treasury Bills auctions on a fortnightly basis and changing 364-day Treasury Bills auctions to a monthly basis. However, this could not be put in place owing to reduced investor interest in Treasury Bills due to unprecedented market developments.

Non-Competitive bidders

1.52  Non-competitive bidders in 14-day and 91-day Treasury Bills auction were being allocated bid amounts within the notified amount.  In other countries, though non-competitive bidders are generally allocated within the notified amounts, such bidders are small investors.  In India, the State Governments, who are the major non-competitive bidders, offer large bid amounts which are also highly volatile, which rendered the pricing pattern and allotment very uncertain for competitive bidders.  Hence, with a view to ensuring transparency and certainty for competitive bidders, it was decided to keep non-competitive bids outside the notified amounts. This measure was announced as a part of Monetary and Credit Policy for the second half of 1997-98, and became effective from April 1, 1998.

Notified amount

1.53  Hitherto, as a transitional arrangement, the amounts of issue were being notified in respect of 91-day Treasury Bills auctions and dated securities while the amounts were not notified in respect of 364-day and 14-day Treasury Bill auctions.  In pursuance of the Monetary and Credit Policy for the second half of 1997-98, it was decided to notify amounts in case of all auctions with effect from April 1,1998.  While the procedure of notifying amounts in all auctions would necessitate the Reserve Bank to participate as a non-competitive bidder, the possibility of devolvement on the Reserve Bank could, however, be reduced through higher underwriting levels by PDs, and adjusting the notified amounts to reflect the market demand.

Auction Method

1.54  The method of multiple price auction is generally being followed at present, wherein every bidder gets allocations according to the actual bids quoted.  The cut-off yield in the case of dated securities and cut-off price in the case of Treasury Bills determine the coupon rate/price and accordingly, all bidders at or below the cut-off yield were allocated upto the notified amount.  It has been decided to introduce uniform price auction method in respect of 91-day Treasury Bill auction, as an experimental measure.  Uniform price auction method is expected to eliminate the problem of winners' curse, encourage both aggressive bidding and secondary market trades.  

Repos by the Reserve Bank

Fixed Rate Repos

1.55  The Reserve Bank decided to conduct fixed rate repos on a three to four day cycle as part of liquidity tightening measures on November 29, 1997.  The Monetary and Credit Policy for the first half of 1998-99 has further proposed to use both fixed interest and auction based repos as appropriate.  Furthermore, in addition to the current three days and four-days repos, it has been proposed to introduce one-day repos (including reverse repos) in due course to absorb (infuse) liquidity from (into) the system.  Although the one-day repo has not yet been introduced, they will provide greater flexibility and maneuverability to the Reserve Bank in managing short-term liquidity.

Ready forward transactions in PSU Bonds and Private Debt Securities

1.56  With a view to expanding the base for repos market and developing the secondary market in public sector undertakings (PSUs) Bonds and private corporate debt securities and for providing liquidity to such instruments, it was decided that ready forward transactions would be permitted in PSU bonds and private corporate debt securities provided they are held, in dematerialised form in a depository and the transactions are done in recognised stock exchanges.  The ready forward transactions in PSU bonds and private corporate debt securities would be initially permitted among those who operate in ready forward transactions in Government securities.

Other Developments

New Instruments - Introduction of Capital Indexed Bonds

1.57  The Government of India decided to introduce Capital Indexed Bonds for the first time where the repayment of the principal amount was indexed to inflation and first such bonds of five year maturity with 6 per cent  coupon were introduced on December 29, 1997.  The inflation adjustment for the repayment of the principal is on the basis of monthly average of the wholesale price index as worked out by the Reserve Bank.  Such bonds provide a complete hedge against inflation for the principal amount of investment to investors and also increase the range of financial assets available in the system.  The sale of these bonds was on tap between December 29, 1997 and January 28, 1998 and the  amount mobilised was Rs.704.5 crore.

Retailing of Government Securities

(i) Scheme of Liquidity Support to Mutual Funds

1.58  In 1996-97, the Reserve Bank had announced a scheme of liquidity support to mutual funds dedicated to investments in gilts and permitted banks to undertake retailing of Government securities with non-bank clients.  In order to promote the retail market segment and to provide greater liquidity to retail investors, in pursuance of the Monetary and Credit Policy for the second half of the year 1997-98, effective October 22, 1997, banks were allowed to freely buy and sell government securities on an outright basis at prevailing market prices, without any restriction on the period between sale and purchase subject to the stipulation that they should not undertake ready forward transactions in Government securities with non-bank clients.

(ii) Constituents' SGL Account with the Reserve Bank

1.59  The Depositories Act was enacted in 1996 enabling holding of securities in dematerialised form.  Following this, National Securities Depository Limited (NSDL) has been established.  NSDL has shown keen interest in bringing Government securities also under its purview. In this context, it may be mentioned that pursuant to the introduction of Delivery Versus Payment (DVP) System for transactions in Government securities held in SGL accounts, the Reserve Bank has phased out the accounts of investors like Provident Funds/Trusts, etc.  The Provident Funds/Trusts, which were earlier enjoying cost-free services from the Reserve Bank in SGL form, have shown reluctance to shift to SGL II (Constituents' Account) of banks.  In these circumstances, the Provident Funds/Trusts have opted for Stock Certificates with the Reserve Bank.  Consequent on the switch over by PFs/Trusts to Stock Certificates, the portfolio of Stock Certificates serviced by the Reserve Bank, Mumbai consists of an overwhelming number of over 50,000 pieces.

1.60  In the above background and with a view to enabling institutions like NSDL, to service the accounts of PFs/Trusts and as a step towards dematerialisation, the following three institutions have been allowed SGL facility in the books of Public Debt Office : (i) National Securities Clearing Corporation Limited (NSCCL), (ii) National Securities Depository Limited (NSDL) and (iii) Stock Holding Corporation of India Limited (SHCIL).  These three institutions aim to assist PFs/Trusts/Individuals in acquiring/holding Government securities in dematerialised form while broadbasing/deepening the retail market for Government securities.

Investment in Central Government Securities by Foreign Institutional Investors (FIIs)

1.61  With a view to encouraging further flow of foreign capital into Indian capital market and help bridge the gap between domestic savings and investment in a more cost effective manner and also to provide more depth and liquidity to the Government securities market, since July 10, 1997, the Foreign Institutional Investors (FIIs) in the category of 100 per cent debt funds have been permitted to invest in Government dated securities.  In pursuance of the Monetary and Credit Policy for the second half of the 1997-98, in addition to the category of 100 per cent debt funds, it was decided to permit FIIs with a ceiling of 30 per cent investments in debt instruments to invest in Government dated securities, within the ceiling of 30 per cent.  Following amendments to SEBI's FIIs' Regulations, this has come into force effective April 20, 1998.  In pursuance of the Monetary and Credit Policy announcements for the first half of 1998-99 to permit all categories of FIIs to purchase/sell Treasury Bills within the overall approved debt ceilings, SEBI  has amended its above notification and it came into force from May 18, 1998. Accordingly, with effect from June 11,1998 the Reserve Bank guidelines was amended to enable equity funds to invest in Government dated securities and Treasury Bills within their debt ceiling of 30 per cent.

Valuation of Government Securities

1.62  It has been the endeavour of  the Reserve Bank to ensure the banks increasingly mark their investments to the market i.e., earmark a higher portion of their investments to the current category to facilitate valuing all the Investments on fully marked to market basis.  Accordingly, the ratio of investments in permanent category was brought down to 40 per cent for the year ending March 1998.  It has further been decided to bring down the ratio for permanent category to 30 per cent for the year ending March 1999.  New private sector banks are required to mark to market their entire investments in approved securities from end-March 1997.  The Monetary and Credit Policy for the first half of 1998-99 has pointed out the need to increase the ratio of current investments in approved securities progressively to 100 per cent in the next three years.  This would be in line with international best practices.

Recapitalisation of Public Sector Banks

1.63  The Government contributed a sum of Rs.2,700 crore during 1997-98 (as against Rs.1,509 crore to six banks during the year 1996-97)¹  towards recapitalisation of three banks, viz., Canara Bank (Rs.600 crore), Indian Bank (Rs.1,750 crore) and UCO Bank (Rs.350 crore).  The capital contribution by the Government to nationalised banks so far amounts to Rs.20,046.12 crore.

Write-off of Capital

1.64  The Government provided a sum of Rs.1,532 crore during the year ended March 1997 to write-off the losses of two banks against their capital.  Accumulated losses to the extent of Rs.1,000 crore and Rs.532 crore were written off against the capital of  Indian Overseas Bank and Allahabad Bank, respectively, during the year ended March 1997.  The write-off cleans up the balance sheets of the concerned banks and enables them to make an early public issue.  Canara Bank was permitted by the Government to reduce its paid-up capital as on Mach 31, 1998 by Rs.507.10 crore against the loss arising from the CanStar Scheme.  The aggregate capital allowed to be written off by nationalised banks till date is Rs.3,978.52 crore.

Refund of Capital

1.65  The Punjab National Bank returned to the Government of India, capital amount of Rs.138.33 crore during the year ended March 31, 1998.  Till date four banks have returned to Government of India, paid-up capital aggregating Rs.642.80 crore.   The reduction in capital results in an improvement in  earning per share and helps the concerned banks in better pricing of their share at the time of public issue.

Public Issue of Shares

1.66  The State Bank of India and the Oriental Bank of Commerce approached the capital market in December 1993 and October 1994 at an issue price of Rs.100 and Rs.60, respectively.  During 1996-97, the Dena Bank, Bank of India and the Bank of Baroda issued their scrips at issue prices of Rs.30, Rs.45 and Rs.85, respectively.  Three PSBs viz., Corporation Bank, State Bank of Bikaner and Jaipur and State Bank of Travancore have accessed the capital market during the year ended March 31, 1998 to raise their capital as given in Table 1.2.  The issues were fully subscribed.  The holding of shares by the Government of India in Corporation Bank subsequent to public issue came down to 68.33 per cent.  As at the end of March 1998, PSBs have raised capital (including premium) worth Rs.6,015 crore, including proceeds from the GDR issue of SBI aggregating Rs.1,270 crore raised during 1996-97

Issue of sub-ordinated debt instruments for inclusion in Tier II capital

1.67  During the year ended March 1998, the following banks raised subordinated debt for inclusion in their Tier II capital.

Supervision of Banks

1.68  The new approach to on-site inspection of banks in accordance with the recommendations of the Padmanabhan Working Group (1995) has been adopted from the cycle of inspections commencing July 1997.  It focuses on the mandated aspects of solvency, liquidity, financial and operational health, based on a modified version of the CAMEL model viz., CAMELS, which evaluates banks' Capital Adequacy, Asset Quality, Management, Earnings, Liquidity and Systems and Control, shedding the audit elements under the existing inspection system.

1.69  As part of the new supervisory strategy piloted by the Board for Financial Supervision (BFS), the Department of Banking Supervision (DBS) of the Reserve Bank set up an off-site surveillance function in 1995 with the primary objectives of monitoring the financial condition of banks in between on-site examinations, identifying banks which show financial deterioration and which could be in trouble in the near future and acting as a trigger for on-site examination of banks.  The major components of this function are the establishment of a computerised data base system based on a prudential supervisory reporting framework which provides quarterly returns of financial data from banks and other credit institutions, building up of a Memory' on all supervised institutions, and setting up a Market Intelligence and Surveillance Unit (MISU).

1.70  The role of external auditors in bank supervision has been strengthened.  Besides auditing the annual accounts, auditors are now required to verify and certify certain other aspects like adherence to statutory liquidity requirements, prudential norms relating to income recognition, classification of borrowal accounts and provisioning as also financial ratios to be disclosed in the balance sheets of banks.  The system of concurrent audit in major branches of all commercial banks has also taken firm root.  The Compliance Officer System' has been further strengthened by advising the banks to designate a senior official of the rank of General Manager as Compliance Officer' to act as a nodal point for ensuring compliance with important Reserve Bank/Government directives/instructions and report directly to Chief Executive Officer.

1.71  Two Supervisory Rating Models based on CAMELS and CACS (Capital adequacy, Asset quality, Compliance and Systems) factors for rating of Indian commercial banks and foreign banks operating in India respectively, have  been worked out on the lines recommended by the Padmanabhan Working Group (1995).  These ratings would enable the Reserve Bank to identify the banks whose condition warrants special supervisory attention.

New Regulatory Framework for NBFCs

1.72  Exercising the powers derived under the amended Reserve Bank Act and in the light of the experience in monitoring of the activities of NBFCs, a new package of regulatory measures was announced by the Reserve Bank in January 1998.  The salient features of the new framework are discussed in details in Chapter IV. Of about 9,000 applications of NBFCs found to be eligible for registration on the basis of minimum Net Owned Fund (NOF) of Rs.25 lakh, the Reserve Bank has already decided on the applications of 7,300 companies. The entire process of registration is expected to be completed by the end of December, 1998. Taking into account both the positive as well as the negative aspects of the NBFC sector, the Reserve Bank and Government have been open to suggestion and advice from experts and market participants to further refine the regulatory framework for NBFCs, develop self-regulatory mechanism for smaller NBFCs, and improve operational effectiveness.

1.73  In order to undertake a comprehensive examination of the regulatory experience so far and the problems that have arisen on the ground, the Government had setup a Task Force to make further recommendations for effective regulation of NBFC sector. The Reserve Bank was closely associated with the work of the Task Force. Proposal of the Task Force are now under consideration of the Government. The Reserve Bank will make appropriate changes in the regulatory framework as soon as decisions of the Government, including any legislative changes that may be required to give effect to Task Force recommendations become available. Until then, NBFCs are advised to strictly adhere the current regulation in force.