On behalf of Indian authorities we would like to express sincere appreciation to the Financial Sector Assessment Program (FSAP) mission team for the constructive and detailed exercise undertaken on various aspects of India’s financial sector. We welcome several of the recommendations in this report, reflecting the overall confluence of our thinking. Some new thoughts that have emerged will engage the attention of the authorities in days ahead.
We underwent FSAP exercise during 2011-12. It is heartening to note that the FSAP team has appreciated the major reforms undertaken and recognized the efforts made by Indian authorities. In addition, as part of our commitment to the Financial Stability Board, we had also undergone a Financial Stability Board (FSB) Peer Review in 2016 with focus on the two areas of Macro-prudential policy framework and Regulation and Supervision of Non-Banking Financial Companies, follow-up action on which is already underway.
Authorities welcome the Board’s decision to discuss India’s FSAP report on a standalone basis. This review has taken place at a time when India is undergoing major financial sector reforms that include introduction of bankruptcy and insolvency framework for corporates, special resolution regime for financial firms, introduction of uniform Goods and Services Tax (GST), measures to curb black money including demonetization, promotion of digitization, improvements in system wide oversight framework and structural reforms to enhance bank resilience and bank recapitalization.
Our track record on successful implementation of the 2011 FSAP recommendations has been reflected in the current FSAP report. The process of change was charted out continuously through reforms by the authorities in close consultation with various stakeholders. The FSAP process helped us immensely in furthering the consensus.
Let me highlight the major developments since the 2011 FSAP, and also a few major issues which were raised during the 2017 FSAP mission.
1. Key Developments since 2011 FSAP
The two main areas of Basel Core Principles, noted during FSAP 2011 have been fully addressed: (i) regarding the oversight of overseas operations of Indian banks by regulators, onsite inspection of overseas branches of Indian banks and information exchange through MoUs and supervisory colleges with overseas regulators have been effectively instituted; and (ii) on large exposure limits, as per the fresh guidelines issued in December 2016, exposure values of a bank to a group of connected counterparties has been capped at 25 percent of the bank’s capital, thus aligning exposure norms for Indian banks with the Basel Committee on Banking Supervision (BCBS) standards. The Reserve Bank of India (RBI) has also issued comprehensive guidelines on Intra-Group Transactions and Exposures, which include related-party transactions. Besides, on the issue of independence and accountability of the regulators, Reserve Bank of India (RBI) does enjoy budgetary autonomy and operational independence and is transparent in its functioning. The legal provisions to terminate tenures of the top functionaries or to supersede decisions of the RBI and the other regulators are just enabling provisions for extra-ordinary situations and de-facto there is no government interference in the functioning of any of the regulators.
On the other recommendation to develop periodical test arrangements to deal with a major disruption to the financial system, we would like to inform that an inter-regulatory technical group under the aegis of Financial Stability and Development Council (FSDC), inter-alia, is responsible for considering risks to systemic financial stability. The inter-regulatory group is chaired by the Governor of the Reserve Bank of India (RBI) and includes members from other regulators. Further, there is an early warning group to co-ordinate the response of government and regulators in times of crisis. The RBI also brings out a Financial Stability Report bi-annually, which also goes into the deliberations of the FSDC and its constituent Groups and provides a structured framework to discuss the issues of major disruption to the financial system. Hence, this recommendation of FSAP 2011 may also be identified as “Partially Implemented”.
Authorities wish to highlight that the Insolvency and Bankruptcy (IBC) Code, 2016 is a major leap and with the enactment of the Financial Resolution and Deposit Insurance Bill, 2017 (FRDI Bill) the resolution framework will get completed. Besides, while disaster recovery tests in face of operational risks are being conducted, broader tests for financial disruptions will be considered in near future.
The Securities and Exchange Board of India (SEBI) has made significant efforts to address the recommendations of the previous FSAP. Amendments to the SEBI Act have granted SEBI additional investigative powers, created a special court that handles criminal cases filed by SEBI, and given SEBI full authority to regulate pooled investment schemes involving a corpus of Rs 1 billion or more.
With the passage and notification of the Pension Fund Regulatory and Development Authority (PFRDA) Act 2013, the Authority has been conferred with a statutory status. Its mandate covers development of the pension sector as also framing of regulations for the advancement of the National Pension System (NPS) and protection of the interest of the subscribers.
The Insurance Laws (Amendment) Act, 2015 provides for enhancement of the foreign investment cap in an Indian Insurance Company from 26% to an explicitly composite limit of 49% to safeguard of Indian ownership and control while providing Insurance Regulatory and Development Authority of India (IRDAI) with enough flexibility to discharge its functions more effectively and efficiently among others.
As FRDI Bill 2017 has already been introduced in August, 2017 and is under consideration of the Parliament. India is at an advanced stage of establishing an efficient resolution framework consistent with the international norms. The authorities therefore, feel that this recommendation of FSAP 2011 may be taken as “Partially Implemented”.
2. India’s views on few major observations on the recommendations made in FSAP 2017
There are several recommendations, which the authorities broadly agree with and many of these are already being implemented. Of course, there are differences in nuance in some of them. There are also some with which the authorities disagree.
(i) Banking and Market Infrastructure
The RBI framework was assessed to be compliant with the Basel Framework under the 2015 Regulatory Consistency Assessment Programme. The capital framework includes a capital conservation buffer, leverage ratio, and countercyclical capital buffer. The framework applies to public as well as private sector banks. The FSSA observes that the RBI offers only the Standardized Approach for credit, market, and operational risk. While currently the RBI is reviewing applications of several banks to apply the Internal Ratings Based (IRB) approach for credit risk, the bank models need to be carefully validated and parallel runs are needed. IRB and advanced approaches are not without pitfalls and robustness of the models need to be established. In recent period, there has been widespread recognition that the IRB approach, based on complex models, is being misused by undercapitalized banks to lower risk weights. Thus, the standardized approach is finding favour with regulators. As such, we are cautious in pushing the IRB approach at this stage.
We appreciate the FSAP team’s concern to phase out the Statutory Liquidity Ratio (SLR). While we reiterate that this is consistent with the authorities view, the move in this direction must factor in the potential market impact. The Report of the Expert Committee to Revise and Strengthen the Monetary Policy Framework in January 2014 had recommended that SLR be brought down in consonance with requirements of the Liquidity Coverage Ratio (LCR) under Basel III framework. Accordingly, the SLR has been brought down in a consistent but gradual manner, and now stands at 19.5 percent down from 23 percent in January 2014.
Divestment of government ownership in public sector banks (PSBs) is envisaged as part of the recapitalisation plan under which PSBs will raise capital from the markets. However, transfer of controlling ownership is not under immediate consideration.
Regarding review of loan classification and provisioning rules with respect to special loan categories, we reiterate that the authorities are in the process of such a review in conjunction with International Financial Reporting Standards (IFRS-9), wherein expected loss framework forms the basis for provisions and all loans are covered by provisioning. This framework will capture past loss data and cure rates in the provisions. Introducing a prudential floor on the lines of IFRS is also envisaged by the authorities. At the same time, it needs to be recognized that in the Indian context, special category loans, which comprise loans primarily to the agriculture sector, do not necessarily violate the prudence principles and instead reflect the inclusion criteria. Repayment of such loans is in consonance with crop seasons and the cash flows of the farmer. Moreover, the Basel Committee on Banking Supervision (BCBS) guidelines issued in 2016 on prudential treatment of problem assets currently provides for supervisory deviation from the 90-day norm and prescribing up to a 180-day norm in case of retail and public sector entities exposure if this is considered appropriate for local conditions.
Regarding the Priority Sector Lending (PSL) norms, they play an important role in providing credit to sectors which do not get access to formal finance and therefore facilitate inclusion, employment and growth. One-size fits all approach, therefore, may not serve a good purpose in this case.
It is worth mentioning here that the RBI’s norms require that even if one facility provided to a borrower is classified as non-performing loans (NPL) due to non-payment, all facilities of the borrowers have to be classified as NPLs. This principle of ‘borrower-wise asset classification’ is applied even in case of retail loans, whereas internationally, retail loans generally attract facility wise classification norms (though subject to a materiality clause). Hence, in that sense the RBI loan classification norms are more stringent than the international practice.
On the FSAP observations on crisis preparedness and Emergency Liquidity Assistance (ELA), it needs to be noted that there are no technical obstacles to extending ELA. In fact, RBI has in place a carefully drafted Board-approved policy on ELA that incorporates constructive ambiguity and flexibility, and as such does not prefer more clarity than is necessary as it could engender moral hazard. It may be noted that the FRDI Bill, 2017 already contains a provision of government grants, in addition to the Resolution Corporation’s (RC) power to charge a premium for providing deposit insurance. Further, on the matter of crisis preparedness, the FRDI Bill 2017 has adequate provisions, including the mechanism of early detection of risks (risk to viability mechanism), identification of systemically important financial institutions (SIFIs), and the requirement to submit restoration and resolution plans. Regarding the Principles of Financial Market Infrastructure, we are happy to inform that the Clearing Corporation of India Limited (CCIL) observes almost all of them. The two principles which are found to be broadly observed are being currently considered for quick implementation. As for the trade repository (TR), the operating regulations for TR services have since received RBI regulatory approval and CCIL has notified the regulations and complied with the principle.
(ii) Capital needs assessment & Recapitalization efforts
Since undercapitalization of PSBs has been the focus of much debate we would like to highlight a significant development that took place soon after this FSAP exercise Though not earlier included in the FSSA report, this development is now reflected through a staff supplement informing the Executive Board of the Government’s recent decision taken on October 24, 2017 to substantially recapitalize PSBs. The recapitalization of Rs. 2.11 trillion (about US$32.5 billion) will be implemented over the next two years. This includes budgetary provisions of Rs.181.39 billion and recapitalisation bonds of Rs.1,350 billion; the balance capital amount is to be raised by the PSBs from the market by diluting government equity. The FSAP team’s stress tests estimated the capital needs of banks between 0.75 percent of GDP in the baseline to 1.5 percent of the GDP in the severe adverse scenario. The team’s assessment was that these capital needs were manageable in aggregate. The findings of the RBI’s own stress tests, the results of which are published in the recent Financial Stability Report released on June 30, 2017, have not been substantially different This recapitalization package will effectively address the capital gap assessed in the FSAP exercise even under the severe stress scenario.
The authorities are also using this window of opportunity to bring about improved governance in PSBs. The bank recapitalization package will be front-loaded through issuance and placement of recapitalization bonds on the balance sheet of banks facing capital shortfall. The package will, however, also be differentiated with the front-loading being greater for banks that have better addressed their balance-sheet issues and which are in a position to use fresh capital injection for immediate credit creation. This will help ameliorate financing constraints faced by parts of the real economy. The intention of the differentiated approach is to link the recapitalization to operational and governance reforms at PSBs, limit moral hazard and ensure that the infused capital is well-used. Furthermore, as a part of the capital needs will be raised from the markets, there will be scope for improved market discipline, contributing to the overall thrust of improving governance in these banks.
The fiscal burden of the recapitalization bonds will get dispersed over time with only the interest burden coming on-budget until redemptions. Therefore, the fiscal deficit burden appears manageable. Moreover, the recapitalisation is cash neutral under the IMF methodology. With banks having adequate liquidity parked in government bonds as excess SLR, this excess liquidity can get reallocated for credit once the bank capital is adequately high to enable credit creation.
The recapitalization plan has been well-received by the markets, with rating agencies already stating it as “significant credit positive”. The authorities are making all out efforts that are likely to turnaround the NPL cycle, strengthen bank balance sheets, improve provisioning coverage, address current fragilities, and ultimately improve banking soundness. The Government has taken several legislative measures to facilitate recovery and resolution of stressed assets. The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act) and the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 were amended in 2016 to enable expeditious recovery of non-performing loans. Further, during the current year the Banking Regulation Act, 1949 was amended to authorize the Reserve Bank of India (RBI) to direct banks to initiate the insolvency resolution process under the rubric of IBC. The institutional infrastructure comprising of National Company Law Tribunals (NCLT) and the National Company Law Appellate Tribunal (NCLAT) to adjudicate corporate appeals has already been operationalized. The Insolvency and Bankruptcy Board of India (IBBI) is in place for oversight and enforcement of rules for insolvency resolution and liquidation in a timebound manner. The other measures taken by RBI include (i) setting up of the Central Repository of Information on Large Credits (CRILC) that helps in tracking not just the NPAs, but incipient stress and inadequate recognition of bad loans; (ii) introducing the Framework for Revitalizing Distressed Assets in the Economy with a special focus on addressing coordination problems in large consortium accounts under Joint Lenders’ Forums (JLF); and (iii) using the revised Prompt Corrective Action (PCA) framework to work towards needed improvements in weak banks.
Ultimately, these efforts, along with the two game-changing moves in 2017 - (a) pushing resolution and insolvency through the recently enacted IBC and (b) the announced recapitalization plan - will not only ensure stability of the Indian financial system but also unleash efficient financial intermediation in support of broader economic impulses.
(iii) Securities & Commodities Markets and Insurance
On the recommendation on the development of risk-based system for selective reviews of listed companies’ reports, and the transfer of legal authority on public listed company reporting from the Ministry of Corporate Affairs to Securities and Exchange Board of India (SEBI), we would like to mention that the Companies Act, 2013 (CA-13) contains the basis/minimum requirements on corporate regulation. Moreover, other regulators like SEBI, RBI, IRDAI etc. have the power to prescribe more detailed regulatory requirements under their sectoral jurisdictions.
We would like to inform that the minimum requirements with respect to preparation, circulation, filing and review of various disclosures through specified reports/returns have been provided under the CA-13. SEBI has specified additional sectoral requirements for listed companies through various regulations. This arrangement has been working well and no change is considered necessary. It may also be noted that Companies Act, 2013 provides for constitution of National Financial Reporting Authority (NFRA) as an independent regulator for audit to ensure complete independence, thoroughness and accountability on the part of auditors.
Sharing of information between Ministry of Corporate Affairs (MCA) and SEBI exists and simultaneous and timely disclosure of information needs to be done on the exchange platforms by the companies.
Regarding unification of commodity markets, Government has announced in the Budget Speech for 2017-18 that “the Commodities markets require further reforms for the benefits of farmers and an Expert Committee will be constituted to study and promote creation of an operational and legal framework to integrate spot market and derivatives market for commodities trading. The electronic National Agriculture Market (e-NAM) would be an integral part of such framework.” The Expert Committee has accordingly been set up on June 13, 2017.
On the recommendation related to introduction of risk-based solvency regime and risk-based supervision for insurers, it is informed that within IRDAI, a Project Committee has already been constituted with the task to study and further develop an appropriate framework of Risk Based Supervision (RBS) and is expected to submit a final report by end of November, 2017. Based on the same, the Authority will review the issues related to enhanced implementation of comprehensive RBS regime. IRDAI is also constituted a steering committee to implement Risk Based Capital (RBC) Regime with broad timeframe of 3 years.
(iv) System Oversight
It is felt that financial sector oversight is well served by the apex coordinator FSDC which ensures smooth inter-regulatory coordination and independence of regulators. Its SubCommittee is vested with the responsibility of analysing, finalizing and approving macroprudential tools. The Government is taking suitable actions to address the recommendations made by the FSB peer review to strengthen the macroprudential policy framework.
On improving systemic risk and macro-prudential oversight, authorities have decided in the FSDC forum that each regulator would formulate macro-prudential policy in their respective areas and bring it to FSDC forum, including cross-sectoral issues, for finalization. The Government also proposes to set up a Financial Data Management Centre (FDMC) mainly to standardize and provide analytical support to the FSDC on issues related to financial stability. We already have an understanding among the regulators to share information towards further improving and expanding the scope for systemic risk analysis. The draft FDMC Bill does not restrict the regulators in maintaining separate database for regulatory purpose and the regulatory powers of regulators remain unaffected. The systemic macro-financial risk factors are also captured in the Financial Stability Report (FSR) published by RBI.
Cyber-attacks and malicious cyber activities in the financial sector is a matter of great concern. The Government has already announced for establishment of a cyber security Computer Emergency Response Team for Finance (CERT-Fin) in the financial sector and working towards the same.
In addition, on the coverage of the Resolution Framework in the FSSA, we note that the observations in FSSA are based on the old Financial Resolution and Deposit Insurance Bill (FRDI) Bill of 2016. The new, FRDI Bill 2017, tabled in the Parliament on August 10, 2017 is a marked improvement over the previous Bill of 2016 and many issues identified/suggestions made in the FSSA in this area have already been resolved in the 2017 Bill.
Authorities wish to highlight that the issues relating to duplication of supervisory authority in the pre-resolution phase, strengthening of resolution tools and safeguards, recovery and resolution plans, treatment of domestic & foreign liability holders, and matter of crisis preparedness have been adequately accommodated in the revised Bill, 2017.
(vi) Infrastructure Finance
On Infrastructure finance, the authorities feel that there is inadequate appreciation of the detailed “diagnostics” made by the Government resulting in the structuring of innovative financing vehicles which have been well received by the market. Various steps to enhance investment in infrastructure sector including launching of innovative financial vehicles such as Infrastructure Debt Funds (IDFs), Real Estate Investment Trusts (REITs)/Infrastructure Investment Trust (InvITs), National Investment and Infrastructure Fund (NIIF), laying down a framework for municipal bonds, allowing complete pass through of income tax to securitization trusts including trusts of Asset Reconstruction Companies (ARCs), bringing in 5/25 Scheme to extend long tenor loans to infrastructure projects, take-out finance, flexible structuring etc. have been taken. Several steps to ensure timely completion of projects have also been taken such as rigorous project appraisal, online computerized monitoring system (OCMS) for better monitoring, setting up of Central Sector Project Coordination Committees (CSPCCs) in states and a Cell called Project Monitoring Group (PMG) in the Cabinet Secretariat for all large projects, both public and private. Central e-PMS, a web enabled information system has also been put in place for monitoring project having investments above Rs.1000 crore (USD 167 million).
We also take note of the FSAP recommendation for transfer of ownership of National Housing Bank to the Government and regulation of Housing Finance Companies to RBI. The RBI had some time back suggested the same and this is under consideration of the Government of India.
3. Other Issues
a) Authorities wish to bring attention to the part of report on Financial Sector Oversight Framework (Supervision and Regulation) which finds mention of Banking Supervision, Insurance Supervision and Securities Regulation and not pension. As enactment of legislation related to NPS and PFRDA was one of the recommendations of the previous FSAP report, this has been implemented, as acknowledged in the report. A para on Pension Sector Supervision and Regulation may be considered for incorporation in the report mentioning the passage of PFRDA Act 2013 and the subsequent notification of regulations for prudential oversight and consumer protection.
b) Regarding mitigation of money laundering risks, significant measures have been undertaken to deter tax evasion
- i. In the context of domestic tax evasion, under the Prevention of Money Laundering Act, 2002 (PMLA) the activity of generation of (black) money is itself unlawful i.e. ‘predicate offence’ and as a result the Government has a right to confiscate that money on the reason that it never belonged to the accused. It may be difficult to consider domestic tax invasion as ‘predicate offence’ to money laundering, the latter offence is criminal in nature and has cross boarder implications. Further, such qualification would be harsh to the tax payers as many times adjustment to income are made based on legal issues and would affect the large number of population.
- ii. Further, incentives in the form of tax rebates to encourage digital payments are not in line with the Government’s taxation policy as it is intended to phase out to all the exemptions and deductions. Such tax rebates would be more beneficial to the taxpayers from higher income group and shall mostly benefit existing users. Further, considering India’s tax base, the proposal would have limited affect, as only the taxpayers would be incentivized and larger population would remain out of the purview of proposed incentives. Instead of providing tax rebates to incentivize digital payments, certain provisions have been put in place to disincentivize cash transaction like all cash transactions relating to sale of goods and services in excess of rupees two lakh are to be reported by the person concerned.
On the whole, we welcome the 2017 FSAP both as a testimony to a sound and vibrant financial system in India that serves a large population at diverse stages of development, as well as for its help in charting out the future course of financial sector reforms. The Indian authorities are pursuing a financial sector agenda which will bring about efficiency, stability, transparency and inclusiveness in the delivery of financial services. The recommendations made by FSAP will further reinforce and guide us terms of sustainable financial sector development, and towards a fundamentally strong and resilient financial system.