understanding finance sector in india

8/9/2019 Understanding Finance Sector in India

1/81

Understanding Finance

Sector

in

India

Dr. Prashant S. Desai

Assistant Professor in Law,

National Law

School

of

India

University,

Bangalore‐560 072.


2/81

Module contents

• Understanding the architecture of finance

sector in

India

• Brief background of ‘regulation’ pertaining to

finance

sector

in

India• Flagging‐up of few ‘challenges’ and ‘grey

areas’ of finance sector

• Contextualizing the

future

discourse


3/81

What is

finance

sector?

• Interestingly the term ‘finance sector’ is

not ‘technically’

or

‘legally’

defined

• There are few explanations


4/81

OECD’s explanation

• “financial sector is the set of institutions,

instruments and

the

regulatory

framework that permit transactions to be

made by

incurring

and

settling

debts;

that is by extending credit”


5/81

Another explanation

• “the term ‘financial system’, implied a set of

complex and

closely

connected

or

interlinked

institutions, agents, practices, markets,

transactions, claims and liabilities in the

economy.

The financial

system

is

concerned

about money, credit and finance – the three

terms

are

intimately

related

yet

are

somewhat

different from each other”


6/81

Yet another

explanation

• “financial institutions are business

organizations that

act

as

mobilizers

and

depositories of savings and as purveyors

of credit

or

finance.

They

also

provide

various financial services to the

community”


7/81

Few more

observations

• The financial institutions differ from non‐

financial (industrial

and

commercial)

business

organizations in respect of their dealings;

•

While

the

former

deal

in

financial

assets

such

as deposits loans securities and so on

• The latter deal in equipment, stocks of goods,

real estate

etc.,


8/81

Indian

finance

sector

• Banking institutions

• Non Banking Finance Companies

• Investment/Merchant banks

• Mutual Funds

• Insurance Companies

• Factoring and Factoring Companies

• Venture Capital Companies

• Housing Finance Companies

• Portfolio Managers

• Micro

Finance

Companies


9/81

Banking institutions

• The institutions doing ‘banking’ business

– Acceptance of

deposits

and

extension

of

credit

facilities

– Recognized as banking companies by the relevant

law (i.e.,

either

their

respective

dedicated

statute

or The Banking Regulation Act, 1949)

•

Roughly

the

Indian

Banks

can

be

classified

as – Scheduled and

– Non‐Scheduled banks


10/81

Non‐banking

finance

companies

• Popularly known as NBFCs

• These are regulated by RBI and allowed to raise deposits from the public

• They offer

financial

services

such

leasing,

hire purchasing, vehicle financing etc.,


11/81

• NBFC is a company registered under the

Companies Act, 1956, engaged in the business

of loans

and

advances,

acquisition

of

shares,

stock, bond, hire‐purchase, insurance

business, or chit business: but does not

include any

institution

whose

principal

business is that of agriculture activity,

industrial activity, sale/purchase/construction

of immovable property.


12/81

• As per

the

RBI

Act,

a 'non

‐banking

financial

company' is defined as:‐

(i)a financial institution which is a company;

(ii)a non

banking

institution

which

is

a company

and

which has as its principal business the receiving of deposits, under any scheme or arrangement or in

any other

manner,

or

lending

in

any

manner;

(iii)such other non‐banking institution or class of such institutions, as the bank may, with the

previous approval

of

the

Central

Government

and

by notification in the Official Gazette, specify.


13/81

• For regulatory purposes, NBFCs have been classified into 3 categories:

a) Those accepting

public

deposits,

b) Those not accepting public deposits but engaged in financial business and

c) Core investment

companies

with

90%

of

their

total assets as investments in the securities of their group/ holding/ subsidiary companies.


14/81

• Depending upon

the

nature

and

type

of

service

provided, they are categorized into:

Asset finance companies

Housing finance

companies

Venture capital funds

Merchant banking organizations

Credit rating

agencies

Factoring and forfaiting organizations

Housing finance companies

Stock brokering

firms

Depositories


15/81

• “Notwithstanding their diversity, NBFCs are characterised

by their

ability

to

provide

niche

financial

services

in

the

Indian economy. Because of their relative organisational

flexibility leading to a better response mechanism, they

are

often

able

to

provide

tailor‐

made

services

relatively

faster than banks and financial institutions. This enables

them to build up a clientele that ranges from small

borrowers to establish corporate. While NBFCs have

often been

leaders

in

financial

innovations,

which

are

capable of enhancing the functional efficiency of the

financial system, instances of unsustainability, often on

account of

high

rates

of

interest

on

their

deposits

and

periodic bankruptcies, underscore the need for

reinforcing their financial viability.”

‐ Report

on

trends

on

progress

of

banking

in

India

2002

‐03


16/81

Investment banks

• Cater to the long term investment requirements

of

the

markets• Generally participate in equity capital of the

company or extension of long term capital

•

A

financial

intermediary

that

performs

a

variety

of services.

This

includes

underwriting,

acting

as

an intermediary between an issuer of securities and the investing public, facilitating mergers

and other

corporate

reorganizations,

and

also

acting as a broker for institutional clients.


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• A mutual fund is a company that pools money

from many

investors

and

invests

in

well

diversified portfolio of sound investment.

• issues securities (units) to the investors (unit

holders) in accordance with the quantum of

money invested by them.

• profit shared

by

the

investors

in

proportion

to

their investments.

Mutual funds


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• set up

in

the

form

of

trust

and

has

a sponsor,

trustee, asset management company and custodian

• advantages in

terms

of

convenience,

lower

risk,

expert management and reduced transaction cost.

• Very critical

in

today’s

financial

services

market

• The funds are invested in various instruments and managed by the Asset Management Companies,

which

act

as

Investment

Manager

of the Mutual Fund


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• They give small investors access to professionally managed, diversified portfolios of equities, bonds

and

other

securities,

which

would

be

quite

difficult to create with a small amount of capital.

• Each shareholder participates proportionally in

the

gain

or

loss

of

the

fund.• Mutual Fund Regulations, 1996 of Securities

Exchange Board of India

•

Mutual Fund

is

also

registered

as

Trust

under

the

Indian Trust Act, 1882


20/81

Mutual

Fund

Operation

Flow

Chart


21/81

Insurance

companies• Commenced playing a dominant role in the

financial markets

especially

after

privatization

• Competition in the insurance sector has

created many attractive insurance products of

different nature to investors at affordable rates

• Regulated by

Insurance

Regulator

Authority

of

India


22/81

Factoring Companies

• Involves the sale of receivables by a company to a financial intermediary who will undertake

the activity

of

maintenance

of

accounts,

collection of debts and financing against receivables

• Not very

much

picked

up

in

India

as

of

now

– Insufficient credit information,

–

Lack

of

data

to

evaluate

the

debtors

and

– Clear assessment of risks factors

– Absence of clear statute to support the activity


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Venture

capital• Is the extension of capital assistance or

participation

by

a

company

or

high

net

worth

investor to assist a start up and untested

project

• This is

to

encourage

upcoming

entrepreneurs

to take up new business initiatives

•

Venture

Capitalists

are

regulated

by

SEBI

under the Venture Capital Regulations


24/81


25/81

Housing

finance

companies• Provide funding to the construction or

purchase of

houses

by

individuals,

companies

etc.,

• Establishment of Housing & Urban

Development Corporation (1970)

• National Housing Bank (as subsidiary of RBI)

• Housing Development

Finance

Company


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• The National Housing Bank has been set up as an apex

institution

under

the

National

Housing

Bank

Act, 1987 on July 9, 1988.

• The objective of the Bank is to operate as a

principal agency

to

promote

housing

finance

institutions both at local and regional levels and to provide financial and other support to such institutions.

• The GoI has

adopted

a comprehensive

National

Housing Policy which envisages development of a viable and accessible institutional system for the

provision of

housing

finance.

The

Banks

have

set

up specialized housing finance institutions.


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Portfolio

managers• Financial service (either by stock broker or

NBFC) to

invest

on

behalf

of

investors

in

shares and stocks

• Especially where – investors do not directly

want to

invest

but

are

interested

in

high

returns from the stock markets

• Portfolio Management services are regulated

under SEBI

(Portfolio)

Management

Regulations


28/81

Micro

finance

companies• Microfinance is the provision of financial services

to low

‐income

clients

or

solidarity

lending

groups

including consumers and the self ‐employed, who

traditionally lack access to banking and related

services.” – Provide self financial assistance to the poor

women in rural areas for the development of

tiny or

small

industrial

growth


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• In India it has grown multifold in recent years

• These companies avail credit facilities from

the bank

to

extend

these

loan

facilities

• Till recently there was no ceiling of loan by these companies nor these companies were

regulated.• However, it is proposed to bring a separate

legislation to regulate these companies and

also proposes

to

cap

the

ceiling

of

lending

by

these companies.


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The regulatory environment


31/81

•

Points

for

Discussion• Principles related to Regulators

• Why regulate finance sector?

• The fundamental underpinning of policies

a) Protection of investors

b) Ensuring that

markets

are

clear,

efficient

&

transparent

c) Reduction

of

systemic

risk• The new emerging challenge


32/81

• Salient features

• Regulatory principles

• Various Regulatory

Bodies

• Financial Sector Legislative Reforms Commission

• Analysis of Financial Sector Reforms

a) Reforms in Banking Sector

b) Reforms in the Government Securities Market

c) Reforms in

the

Foreign

Exchange

Market


33/81

• Regulation refers

to

controlling

human

or

societal

behavior by rules or regulations or alternatively a rule or order issued by an executive authority or

regulatory agency

of

a government

and

having

the force of law.

• Financial regulation deals with directing the

financial institutions

like

banks,

insurance

companies, mortgage loan companies, etc.to fulfill certain requirements, imposing certain restrictions and setting out guidelines so as to keep up the integrity of the entire financial system.


34/81

Principles

related

to

Regulators• The regulators should have clearly & objectively

stated

responsibilities;

• they should have operational independence & accountability in the exercise of its powers &

functions;

• they should adopt clear & consistent regulatory processes;

•

they should

observe

the

highest

professional

standards including appropriate standards of confidentiality.


35/81

Why

regulate

finance

sector?• Obvious answer…

– That every

human

conduct

has

to

be

regulated

from the societal point of view

• Specific answer…

– Regulation to encompass all activities/institution of finance sector in order to ensure equity in their

conduct, so that end users are given a fair deal

and any

unscrupulous

players

dealt

with

firm

hand


36/81

The fundamental underpinning of

policies1. the economic stability

a. Reduction

of

‘systemic

risks’

b. Maintenance of ‘customer confidence’ (by prevention

of market abuse and fraudulent activities)

2. Necessary support

for

overall

equitable

economic development

3. Investor interest protection

4. Of course … the better protection of the

financial sector operators themselves


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Protection

of

investors• Investors are required to be protected from being

mislead or manipulated from fraudulent practices including

insider

trading

and

misuse

of

client

assets.

• It is the task of the regulator to set minimum

standard for

market

participants

in

order

to

achieve a level of investor protection.

• The market intermediaries should be able to refer

to

rules

of

business

conduct

that

ensure

that

investors will

be

treated

in

a just

and

equitable

manner.


38/81

Ensuring that markets are clear,

efficient &

transparent

• It is the task of the regulator to ensure that

there are

regulations

for

the

protection

of

the

investor and to ensure fairness while at the

same time ensuring that there is efficient and

transparent dissemination

of

information.


39/81

Reduction

of

systemic

risk• No amount of regulation or oversight can

guarantee

against

the

possibility

of

financial

failure of a market intermediary.

• However, regulation can and should aim to

reduce the

risk

of

failure.

Where

such

failure

does occur, it is the role of the regulator to seek to reduce the impact of that failure and

to attempt

to

isolate

the

risk

solely

to

the

failing institution.


40/81

The

new

emerging

challenge• Globalizing trend (reduction of

geographical boundaries)

has

further

added to the complexity of the

regulation

of

financial

sector


41/81

Salient

features• The counter trend (compared to generic trend

of liberalization)

from

lesser

to

more

‘stringent’ regulation

• Emerging global consciousness

• Broad ‘sustentative’ legislation: and plethora

of ‘subordinate’ legislation


42/81

Regulatory

principles

RULE

BASED

REGULATION Less

discretionary

&

regulator

is

guided by the ‘letter of law’

PRINCIPLE

BASED

REGULATION

Greater latitude to the market

players – fosters

a culture

of

mutual

trust and faith in the regulator,

DISCRETION BASED

REGULATION

More discretion

with

the

regulator

making him more powerful


43/81

CENTRAL GOVERNMENT

IRDA

INSURANCE COMPANIES

SEBI

STOCK EXCHANGE

MERCHANT BANKERS

PORTFOLIO MANGERS

MUTUAL FUNDS

FACTORING

RBI

BANKS

NBFCS

CO‐OPERATIVE BANKS

PRIMARY DEALERS

PAYMENT SYSTEMS

FMC

COMMODITY EXCHANGES

PENSION REGULATORY AUTHORITY

PENSION FUNDS/

COMPANIES


44/81

Various

Regulatory

Bodies• RBI – it is the central banking regulatory that

governs the monetary policy of the Indian Rupee.

• The Regulation

&

supervision

of

banks

are

key

elements of a financial safety net as banks are often found at the center of systemic financial

crisis.

• The Reserve Bank regulates & supervises the major part of the financial system. The supervisory role of the Reserve Bank covers commercial

banks,

urban

cooperative

banks,

some FIs & NBFCs.


45/81

•

Some of

the

FIs,

in

turn,

regulates

and/or

supervise

other institutions in the financial sector, viz., RRB &

central and state cooperative banks are supervised

by

NABARD,

and

housing

finance

companies

by

National Housing Bank (NHB).

• Its objectives are to maintain public confidence in

the system,

protect

depositor’s

interest

and

provide

cost‐effective banking services to the public.

• The Banking Ombudsman Scheme has been

formulated by

the

RBI

for

effective

addressing

of

complaints by bank customers.


46/81

•

The

RBI

controls

the

monetary

supply,

monitors

economic indicators

like

the

gross

domestic

product and has to decide the design of the rupee banknotes as well as coins. In accordance

with provisions

of

the

RBI

Act,

1934

its

main

functions are:

i. Operating monetary policy with the aim of

maintaining

economic

and

financial

stability

and

ensuring adequate

financial

resources

for

development purposes;

ii. Meeting the currency requirement of the

public;iii. Promotion of an efficient financial system;


47/81

iv. Foreign exchange reserve management;

v. The conduct

of

banking

and

financial

operations of the government.

• “To regulate the issue of Bank Notes and

keeping of reserves with a view to securing

monetary stability in India and generally to

operate the

currency

and

credit

system

of

the

country to its advantage.”


48/81

• SEBI – it is

a statutory

body

that

governs

the

securities market of India with a view of protecting the interest of investors.

• This body

lays

down

regulations

in

order

to

ensure orderly growth and smooth functioning of the Indian Capital market.

• The overall objectives of SEBI are to protect the interest of investors and to promote the

development

of

stock

exchanges

and

to

regulate the activities of stock market.


49/81

Protective Functions of SEBI

• This function is performed by SEBI to protect

the

interest

of

investor

and

provide

safety

of

investment.

• SEBI checks price rigging, prohibits insider

trading, prohibits

fraudulent

and

unfair

trade

practices in which it does not allow the companies to make misleading statements

which are

likely

to

induce

the

sale

and

purchase of securities by any other person.


50/81

Developmental Functions of SEBI

• These functions are performed by SEBI to

promote and

develop

activities

in

stock

exchange and increase the business in stock

exchange.

• SEBI promotes

training

of

intermediaries

of

the securities market, tries to promote

activities

of

the

stock

exchange

by

adopting

flexible and adoptable approach.


51/81

Regulatory Functions of SEBI

• It has framed rules & regulations and a code of conduct to regulate the intermediaries such as

merchant bankers,

brokers,

under

writers,

etc.

• It registers and regulates the working of stock brokers, sub brokers, share transfer agents, and

all

those

who

are

associated

with

stock

exchange

in any manner.

• It registers and regulates the working of mutual funds etc.

• It regulates

takeover

of

companies.

• It conducts inquiries and audit of stock exchanges


52/81

Forward Markets Commission (FMC)

• It is the chief regulator of forwards and futures market in India.

• It is

a statutory

body

set

up

under

the

Forward

Contracts (Regulation) Act, 1952

• It regulates the commodity derivative markets and brokers.

• It provides regulatory oversight in order to ensure financial integrity (i.e. to prevent systemic risk of default by one major operator or group of operators),

market

integrity

(i.e.

to

ensure

that

future

prices

are

truly aligned with the prospective demand and supply conditions) and to protect & promote interests of consumers/ non‐members.


53/81

• The forward market commission performs the

role of

a market

regulator.

After

assessing

the

market situation and taking into account the

recommendations made by the Board of

Directors of

the

Commodity

Exchange,

the

Commission approves the rules and

regulations of the Exchange in accordance

with which

trading

is

to

be

conducted.

Insurance Regulatory and Development


54/81

g y p

Authority• It is an autonomous apex statutory body which

regulates and develops the insurance industry in India.

• It is responsible to protect the rights of policyholders.

• Its role

and

responsibilities

involves

providing

certificate of registration to a life insurance company, to frame regulations on protection of policyholder’s interests, specifying the requisite qualifications, code of

conduct

and

practical

training

for

intermediaries

or

insurance intermediaries and agents.

• It also aims to promote and regulate activities of

professional

organizations

connected

with

life

insurance, to adjudicate disputes between insurers and intermediaries or insurance intermediaries etc.

Pension fund Regulatory and Development


55/81

Pension fund Regulatory and Development

Authority• PFRDA‐ it is an agency which promotes old age

income security by regulating and developing pension

funds.

• The National Pension System Trust is composed of members representing diverse fields and brings

wide

range

of

talent

to

the

regulatory

framework.

• It also intends to intensify its effort towards financial

education

and

awareness

as

a part

of

its

strategy to protect the interest of the subscribers.


56/81

• Ministry of Finance – it is concerned with

taxation, union budgets, capital markets and

finances for

the

Centre

and

State.

• High Level Coordination Committee – it

maintains coordination

between

the

regulators.

Financial Sector Legislative Reforms


57/81

g

Commission• The Union Ministry of Finance constituted the FSLRC in

March 2011, with a mandate to review and suggest changes to existing laws & regulatory institutions in the

financial sector

to

bring

them

up

to

speed

with

globally

prevalent standards.

• Two years later, a report was released which advocated a comprehensive overhaul of the existing regulatory

framework, including

the

replacement

of

a substantial

body of existing laws with the Indian Financial Code drafted by FSLRC.

• FSLRC has its responsibility of reviewing, simplifying and

modernizing

the

legislations

affecting

the

financial

markets.


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• FSLRC

has

endorsed

a transition

to

a more

scientific regulatory architecture recommended by government reports such as Raghuram RajanCommittee report and Percy Mistry Committee

report.• The lesson learnt from the global economic

downturn pressed FSLRC to propose a new

regulatory framework.

• The three elements in FSLRC approach are:‐

1. Modes of independence

2. Accountability3. Rule making process of regulators.

• The regulatory objectives should be clearly defined


59/81

The regulatory objectives should be clearly defined.

• The

regulator

should

be

empowered

with

respective

instruments that do not prevent innovation.

• At times the regulator might have to choose between innovation and reducing risk, but eliminating risk altogether is not a good option as it will restrict finance from reaching out to new customers, products and markets, thus restricting the power of the regulator.

• With a vision

to

protect

public

interest

FSLRC

emphasizes on governance of regulation. Regulators will be independent but should be accountable. It

discourages

the

idea

of

bringing

too

many

innovations

in the financial system and echoes to keep it simple but powerful.


60/81

• The FSLRC has suggested the creation of the Unified Financial Agency (UFA), a new body which would be entrusted with micro‐prudential

regulation and

consumer

protection

for

all

financial sectors other than banking and payment systems.

•

This

body

would

subsume

the

existing

regulators

for capital markets (SEBI), forward markets (Forward Market Commission), insurance (IRDA) and pension (Pension Fund Regulatory and

Development Authority).


61/81

• RBI would continue in the new setup as the regulator for banking and payment systems

and frame

monetary

policy.

• RBI would also be responsible for capital outflows from the country, a change from the

present model

where

the

RBI

makes

rules

for

capital account transactions in consultation with the government and vice‐versa for

current account

transactions.


62/81

• The FSLRC

also

envisages

the

creation

of

the

Public Debt Management Agency (PDMA), an independent body which will take over the task of handling governmental market borrowings from the

RBI,

and

will

additionally

manage

the

cash

and contingent liabilities of the government.

• The Financial Stability and Development Council,

which currently

comprises

various

sectoral

regulators and officials of the Ministry of Finance, will be granted the status of a statutory body & will be responsible for managing systemic risks and

coordinating

between

different

regulatory

agencies.


63/81

• The FSLRC has suggested the creation of a

Resolution Corporation in place of the Deposit

Insurance and

Credit

Guarantee

Corporation

to assist in the speedy resolution and closure

of all systematically important financial

institutions or

those

having

strong

linkages

to

consumers such as banks, insurance

companies

or

pension

funds.


64/81

•

Financial

Redressal

Agency

(FRA)

would

be

operating as a consumer grievance redressalmechanism across the financial sector.

• Appeals from the FRA and decisions in respect of

certain functions

of

the

UFA,

the

RBI

and

the

Resolution Corporation, will be heard by the Financial Sector Appellate Tribunal (FSAT), within

which

the

Securities

Appellate

Tribunal

will

be

subsumed.

• Additionally, the FSAT will be empowered to review regulations on grounds like procedural

defects, the

regulator

exceeding

its

mandate,

or

the regulations being in violation of the Code.

Analysis of Financial Sector Reforms


65/81

Analysis of Financial Sector Reforms

• Remove financial repression that existed earlier;

• Create an efficient, productive and profitable financial sector industry;

• Enable

price

discovery,

particularly,

by

the

market determination of interest rates that then helps efficient allocation of resources;

• Provide operational

and

functional

autonomy

to institutions;

P th fi i l t f i i


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• Prepare the financial system for increasing

international competition;

• Open the external sector in a calibrated fashion;

• Promote the

maintenance

of

financial

stability

even in the face of domestic and external shocks.

• The main aim of the reforms in the early phase of

reforms, known

as

first

generation

of

reforms,

was to create an efficient, productive and

profitable financial service industry operating

within the

environment

of

operating

flexibility

and functional autonomy.

Panchasutra or five principles


67/81

Panchasutra or five principles

• Cautious and appropriate sequencing of

reform

measures.• Introduction of norms that are mutually

reinforcing.

• Introduction of

complementary

reforms

across

sectors.

• Development

of

financial

institutions.

• Development of financial markets.

Reforms in Banking Sector


68/81

g

• Prudential Measures

1) Introduction & phased implementation of international best practices and norms on risk‐weighted

capital

adequacy

requirement,

accounting,

income recognition, provisioning and exposure.

2) Measures to strengthen risk management through

recognition of

different

components

of

risk,

assignment of risk‐weights to various asset classes, norms on connected lending, risk concentration, application of market‐to‐market principle for investment portfolio & limits on deployment of fund in sensitive activities.

• Competition Enhancing Measures


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Competition

Enhancing

Measures

1) Granting of

operational

autonomy

to

public

sector banks, reduction of public ownership in public sector banks by allowing them to raise

capital from

equity

market

up

to

49%

of

paid

‐up

capital.

2) Transparent norms for entry of Indian Private sector, foreign & joint‐venture banks & insurance

companies,

permission

for

foreign

investment in the financial sector in the form of FDI as well as portfolio investment, permission

to banks

to

diversify

product

portfolio

&

business activities.


70/81

• Measures

Enhancing

Role

of

Market

Forces

1) Sharp reduction of pre‐emption through reserve requirement, market determined pricing for

government securities,

disbanding

of

administered interest rates with a few exceptions & enhanced transparency &

disclosure

norms

to

facilitate

market

discipline.2) Introduction of pure inter‐bank call money market, auction‐based repos‐reverse repos for short‐term liquidity management, facilitation of

improved payments

and

settlement

mechanism.


71/81

• Institutional

&

Legal

measures1) Setting up of Lok Adalats, DRTs, ARCs, Settlement

advisory committees, corporate debt restructuring mechanism, etc. for quicker recovery/restructuring.

Promulgation of

SARFAESI

Act

&

its

subsequent

amendment to ensure creditor rights.

2) Setting up of Credit Information Bureau for information sharing on defaulters as also other borrowers.

3) Setting up of Clearing Corporation of India Ltd. (CCIL) to act as central counter party for facilitating

payments

&

settlement

system

relating

to

fixed

income securities

&

money

market

instruments.

• Supervisory Measures


72/81

1) Establishment of

the

Board

for

Financial

Supervision as the apex supervisory authority for commercial banks, financial institutions and NBFCs.

2) Introduction of

CAMELS

( Capital

Adequacy,

Assets, Management Capability, Earnings, Liquidity, Sensitivity) supervisory rating system,

move towards

risk

‐based

supervision,

consolidated supervision of financial conglomerates, strengthening of off ‐site surveillance through control returns.

3) Recasting of

the

role

of

statutory

auditors,

increased internal control through strengthening of internal audit.


73/81

• Strengthening corporate governance, enhanced

due diligence on important shareholders, fit and

proper

tests

for

directors.• Technology Related Measures

• Setting up of INFINET as the communication

backbone for

the

financial

sector,

introduction

of

Negotiated Dealing System (NDS) for screen‐

based trading in government securities and Real

Time Settlement

(RTGS)

System.

Reforms in the Government Securities


74/81

Market• Institutional

Measures

•

Administered

interest

rates

on

govt.

securities

were replaced by an auction system for price discovery.

•

Automatic monetization

of

fiscal

deficit

trough

the issue of ad hoc Treasury Bills was phased out.

• Primary Dealers

were

introduced

as

market

makers in the government securities market.

• For ensuring transparency in the trading of govt.


75/81

securities, Delivery

versus

Payment

settlement

system

was introduced.

• Repurchase agreement (repo) was introduced as a tool of short‐term liquidity adjustment. Subsequently, the

Liquidity Adjustment

Facility

(LAF)

was

introduced.

LAF

operates through repo and reverse repo auctions to set up a corridor for short‐term interest rate. LAF has emerged as the tool for both liquidity management

and also

signaling

device

for

interest

rates

in

the

overnight market.

• Market Stabilization Scheme (MSS) has been introduced, which has expanded the instruments

available to

the

Reserve

Bank

for

managing

the

surplus

liquidity in the system.

• Enabling Measures


76/81

g

• Foreign Institutional

Investors

(FIIs)

were

allowed

to

invest in government securities subject to certain limits.

•

Introduction

of

automated

screen‐

based

trading

in

government securities through Negotiated Dealing System(NDS). Setting up of risk‐free payments and settlement system in govt. securities through Clearing

Corporation

of

India

Ltd

(CCIL).

Phased

introduction

of

Real Time Gross Settlement System (RTGS).

• Introduction of trading of government securities on stock exchanges for promoting retailing in such

securities, permitting

non

‐banks

to

participate

in

repo

market.

Reforms in the Foreign Exchange


77/81

Market• Exchange Rate Regime

• Evolution of exchange rate regime from a single‐

currency fixed

‐exchange

rate

system

to

fixing

the

value

of rupee against a basket of currencies & further to market‐determined floating exchange rate regime.

• Adoption

of

convertibility

of

rupee

for

current

account

transactions with acceptance of Article VIII of the Articles of Agreement of the IMF. De facto full capital account convertibility for non residents and calibrated

liberalization of

transactions

undertaken

for

capital

account purposes in the case of residents.


78/81

• Institutional Framework

•

Replacement of

the

earlier

FERA,

1973

by

the

market friendly FEMA, 1999. delegation of

considerable powers by RBI to Authorized

Dealers to

release

foreign

exchange

for

a

variety of purposes.


79/81

• Increase in Instruments in the Foreign Exchange Market

• Development of

rupee

‐foreign

currency

swap

market.

• Introduction of additional hedging instruments,

such as,

foreign

currency

‐rupee

options.

Authorized dealers permitted to use innovative products like cross‐currency options, interest rate and currency swaps, caps/collars and forward

rate agreements

(FRAs)

in

the

international

forex

market.

• Liberalization Measures


80/81

Liberalization

Measures

• Authorized dealers permitted to initiate trading

positions, borrow and invest in overseas market

subject to

certain

specifications

and

ratification

by respective Banks’ Boards. Banks are also

permitted to fix interest rates on non‐resident

deposits, subject

to

certain

specifications,

use

derivative products for asset‐liability

management and fix overnight open position

limits and

gap

limits

in

the

foreign

exchange

market, subject to ratification by RBI.

•


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Permission

to

various

participants

in

the

foreign

exchange market, including exporters, Indians investing abroad, Foreign Institutional Investors (FIIs), to avail forward cover and enter into swap

transactions without

any

limit

subject

to

genuine

underlying exposure.

• FIIs and NRIs permitted to trade in exchange‐

traded

derivative

contracts

subject

to

certain

conditions.

• Foreign exchange earners permitted to maintain foreign currency accounts. Residents are permitted

to

open

such

accounts

within

the

general limit of US $ 25,000 per year.

understanding finance sector in india

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