PCCFSAP_30Mar

8/2/2019 PCCFSAP_30Mar

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Rakesh MohanDeputy Governor

Reserve Bank of IndiaandChairman, CFSA

Financial SectorAssessment


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What is an FSAP?

The Financial Sector Assessment Program isan IMF-World Bank initiative

A comprehensive health check of the financial

systemA review of strengths, vulnerabilities and

weaknesses

Measures compliance with international financial

standards and codes

Initiated after the1997 Asian financial crisis


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Presentation Outline

Part I: The FSAP and Self-AssessmentA. Background and Timing

B. Macroeconomic Outlook and Vulnerabilities

C. Stability Assessment & Stress Testing

Part II: Lessons and Issues from the AssessmentD-F. Financial Institutions, Markets and Infrastructure

G. Transparency and Developmental Issues

Part III: Transparent Reporting

H. Peer Reviewers CommentsI. CFSA and Advisory PanelsSome Differences

Part IV: Conclusions and Concerns

J. Summary of Assessment

K. Main Concerns


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Part IThe FSAP and Self-Assessment


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A. Background and Timing


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Background and Timing (1)The Story So Far

IMF-WB FSAP in 2001, self-assessment ofinternational standards and codes in 2002,reviewed again in 2005

Set up CFSA in 2006

India among the first country to undertakecomprehensive and holistic self-assessment of

financial sectorPost-crisis, emphasis by the G-20


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Background and Timing (2)Overview of Self-Assessment

Approach and MethodologyPillar I Macro-prudential

surveillance and financial stability

analysisPillar II Legal and institutional

frameworks review

Pillar III International financial

standards and codes: assessment and

status of implementation


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Background and Timing (3)The Process

Benefits

Composition of CFSA: ownership and commitment

Regulatory cooperation: GoI, RBI, SEBI, IRDA, otheragencies

Involvement of experts: advisory panels

Peer reviews: Impartiality

Learning and capacity-building: involvement ofprofessionals

ExecutionComplex issuesapproach with humility

Broad directions instead of specifics in the current context

Focus on Transparent Reporting : Differing opinions of

CFSA and Panels covered in the report


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B. Macroeconomic Outlook andVulnerabilities


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Macroeconomic Outlook and Vulnerabilities (1)The Growth Story

Growth in recent period contributed by severalfactors

High domestic demand

Productivity

Credit growth

High levels of savings and investment

Current global financial crisis: shift from benign

outlook to one of uncertainty

8 %+ growth sustainable in the medium-term due to

high demand; deceleration in the short-term


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Macroeconomic Outlook and Vulnerabilities (2)Pressing Challenges

Need for revival of growth in agricultureAddress restoration of the fiscal reform path

Continuation of financial sector consolidation

and developmentAddress the infrastructure deficit

Complement bank financing with bondmarket development

Insurance and pension reforms

FCAC desirable, but with concomitantmacroeconomic and market developments


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C. Stability Assessment and

Stress Testing


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Stability Assessment and Stress Testing (1)Main Findings

Financial Institutions

Commercial Banks: financially robust

NBFCs and HFCs: healthy financial indicators

Some financing concerns

UCBs and RRBs: improvements in financials

governance concernsRural Co-operative Sector

significant weaknesses


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Stability Assessment and Stress Testing (2)Financial Soundness Indicators

Commercial Banks - Broad improvement in the post-reform period

Financial Soundness Indicators 2000 2008

CRAR 11.1 13.0

Gross NPAs to Gross Advances 13.1 2.4

Net NPAs to Net Advances 7.1 1.1

Return on Total Assets 0.7 1.0

Return on Equity 12.7 12.5

Efficiency (Cost Income) Ratio 61.2 48.9


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Stability Assessment and Stress Testing (3)Financial Soundness Indicators

Other Institutions - Broad improvement in the post-reform period Rural Co-operative Sector someconcerns

NBFCs -

D HFCs

Scheduled

UCBs RRBs

StCBs/

DCCBs2004 2008 2004 2008 2005 2008 2005 2008 2005 2007

CRAR 26.8 22.4 15.0 18.1 12.7 11.9 ---- ---- ---- ----Gross

NPAsRatio

8.2 1.5 3.6 2.2 24.8 14.2 8.5* 5.9*

16.3

19.9

14.2

18.5

RoA* 2.5 2.9 1.9 2.2 0.3 0.7 1.0 1.10.40.7

0.30.02

* Ratio to Total Assets


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Stability Assessment and Stress Testing (4)Stress Testing

What is Stress Testing

Techniques to assess vulnerability of the financial systemin the face of shocks;

identifies how portfolios respond to changes in key

economic variables: e.g., interest rates, credit quality Coverage of stress tests

Credit risk

Market/interest rate risk

Liquidity risk Open positions in foreign exchange much below regulatory

limitsExchange rate tests not undertaken


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Stability Assessment and Stress Testing (5)Credit Risk

Without Stress

Scenario - increase in NPA by:

100 per cent 150 per cent

CRAR (%) CRAR (%) CRAR (%)

Mar-08 13.0 11.6 11.0

Sept08 12.5 11.1 10.6

Note: CRAR = credit to risk assets ratio

Concerns about credit risk remain muted atpresent

Need for close monitoring of such risks in

the current scenario


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Stability Assessment and Stress Testing (6)Interest rate risk

Higher the DoE (duration of equity), greater thesensitivity of banks capital to interest rate shocks

Calculates the erosion in accounting capital due to

unit increase in interest rate

Period Mar-06 Mar-07 Mar-08 Sep-08

DoE(yrs) 14.1 12.0 8.0 8.1

The annualised yield volatility is estimated at 244 bps

Given a DoE of 8.1 years, a 244 bps shock implies an

erosion of 20 per cent of capital and reserves.

=> Better management of interest rate risk by

commercial banks over time


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Stability Assessment and Stress Testing (7)An Overview of Liquidity Ratios

Ratio Mar-05 Mar-08 Sep-08(Volatile Liabilities Temporary Assets) /(Earning Assets Temporary Assets) (percent) (High and positive number impliessome risk of funding liquidity.)

34.7 43.9 49.3

(Core Deposits) / Total Assets (per cent) -(Extent to which assets are fundedthrough stable deposit base)

53.8 49.3 47.7

(Loans + Mandatory CRR + MandatorySLR + Fixed Assets) / Total Assets (per

cent)

(Embedded illiquidity in the balancesheet)

75.0 86.3 86.5

(Loans + Mandatory CRR + MandatorySLR + Fixed Assets) / Core Deposits

(Dependence on purchased liquidity)

1.4 1.8 1.8


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Stability Assessment and Stress Testing (8)Liquidity Risk Management

Gradual, growing dependence on

purchased liquidity

Increase in illiquid parts of banks

balance sheets

Greater reliance on volatile

liabilities for asset growth


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Stability Assessment and Stress Testing (9)The Way Forward

In Sum:

Commercial Banking SystemBroadly Sound

Can withstand significant shocks from large

potential changesPossible Next Steps:

Need to strengthen liquidity management

Stress Testing by individual banksPeriodic scenario testing by RBI

Setting up of a Financial Stability Unit


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Part II

Lessons and Issues

From the Assessment


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D. Financial Institutions


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Financial Institutions (1)Regulation and Supervision

Inherent linkages across institutions

Inter-bank

Bank and non-banks

Basel Core Principles not applicable to:

Co-operative Sector; Regional Rural Banks;

NBFCs; HFCs

But, Assessment done for health check

Results: Generally satisfactory


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Financial Institutions (2)Basel Core Principles: A Compliance Summary

Assessment CB UCB StCB/

DCCB

RRB NBFC HFC

Compliant 7 4 3 4 1 2

Largely Compliant 11 11 10 8 13 10

Materially Non-compliant 6 4 6 6 2 5

Non-compliant 1 2 2 2 8 8

Not applicable - 4 4 5 1 -


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Financial Institutions (3)Basel Core Principles: A Compliance Summary

Major Gaps:

All Institutions: Risk management (for commercial banks the level of

compliance is comparatively lower in respect of banking groups); home-

host country regulationCommercial Banks: Exposure to related parties; non-compliance in

respect to interest rate risk in banking book for which guidelines have

since been issued

Rural & Co-operative Banks: Dual Control; internal control; corporategovernance

NBFCs: Major acquisitions, transfer of significant ownership, internal

control

HFCs: Permissible activities; internal control


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Financial Institutions (4)Commercial Banks Oversight

Government ownership poses dilemmasPossibility of conflicts of interest minimised

through even-handed regulation

Capital augmentation of PSBs is a challenge,but could be managed through a variety ofways

Amalgamation where commercial synergies

existNewer instruments

Through selective dilution of government equity


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Financial Institutions (5)Banking For The 21st Century

Capacity Building:

Training

Succession Planning

Lateral RecruitmentImproved remunerationbut discourage

excessive risk taking

Corporate Governance:

Improve governance inPSBs

Roadmap for foreign banks

A well-considered approach within the

WTO norms

Fi i l I tit ti (6)


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Financial Institutions (6)New Competition Act: Some Issues

Power of Competition Commission to regulate combination Any combination required to be notified to Commission

Maximum period of wait 210 days

RBI may be able to give sanction only after getting order ofCommission or wait for 210 days

Delays the process Possibility of regulatory conflict as order of any statutory

authority not binding on Commission Could lead to regulatory overlap and conflict

Central Government could give necessary exemption under

Section 54 of the Competition (Amendment) Act 2007

Fi i l I tit ti (7)


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Financial Institutions (7)Risk Management and Governance

Conservative risk management matters Counter-cyclical prudential measures by RBI

Off-balance sheet items: Better accounting, disclosure

Capital charge if reliance on purchased liquidity beyond a threshold

Consolidation Encourage market-based consolidation

Co-operative and rural banks need better governance

Dual control: improve corporate governance

Regulation and supervision of rural financial sector: role for RBI andNABARD

Fi i l I i i (8)


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Financial Institutions (8)Non-Bank Financial Services

NBFCs are key players in financial markets

Corporate bond market development would easefunding constraints

Development of regulatory structure for financialconglomerates

Prudential regulations of NBFCs strengthenedsome way to go

Housing finance: growing and important segment

National Housing Price Index, Housing Starts Indexa priority

Regulation of HFCs should be entrusted to RBIGovernments stance status uo

Financial Institutions (9)


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Financial Institutions (9)An Assessment of Insurance

Assessment Number of

Principles

Observed 5

Largely Observed 13

Partly Observed 10

Not Observed -

The level of compliance of the Insurance Sector to IAIS Core Principles

Fi i l I tit ti (10)


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Financial Institutions (10)An Assessment of Insurance

Significant growth in size, penetration and diversified

products

Comfortable solvency and capital adequacy

But gaps/issues remain

Increase supervisory powers of IRDA

Group-wide supervisioneffective policy to be put in

place

Risk Management

Further requirement of skilled professionalsactuaries,

treasury managers


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E. Financial Markets

Fi i l M k (1)


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Financial Markets (1)Regulation and Supervision

Systemic stability

Importance of markets other than

equity marketIOSCO Principles extended to:

G-Sec markets; Forex Markets; Money

MarketsResults: Generally satisfactory

Fi i l M k t (2)


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Financial Markets (2)Foreign Exchange Market

Fastest growing market globally Total annual turnover increased from USD 1.3

trillion during 1997-98 to USD 12.3 trillion during

2007-08

Derivatives:

High growth in forward market

Forex futures introduced in 2008

Need for monitoring and regulation

Customer appropriateness and product suitability

Fi i l M k t (3)


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Financial Markets (3)Sovereign Debt Market

Significant growth in volume and

liquidity

Further diversification of investor baseneeded

Foreign investor participation: proceed

with care

Increase in tradable assets desirable

Large proportion parked in HTM category

Fi i l M k t (4)


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Financial Markets (4)Equity Market

Significant improvement in market andsettlement infrastructure

Functions in robust regulatory environment

Very high compliance with IOSCOPrinciples

Risk management by market participants

Strengthening of inter-exchangesurveillance

Need to improve IPO processes

Setting up of Central Integrated Platform

Fi i l M k t (5)


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Financial Markets (5)Money Market

Liquid marketIncreased share of repo and CBLO

Need for active interest rate futures market

Being re-introduced

Development of term money market

Development of short-end yield curve

necessary

Under examination in TAC Group

Development of the repo market

Financial Markets (6)


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Financial Markets (6)Other Market Segments

Need to develop corporate bond market

Develop credit risk transfer mechanism

But with appropriate checks and

balances

Capacity building in financial

institutions with regard to securitisationand credit derivatives



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Financial Markets (7)Compliance With IOSCO

Markets/

Assessment

Equities Foreignexchange

Govt.

securitiesMoney

market

Fully

Implemented

20 16 19 19

Broadly

Implemented8 - 2 4

PartlyImplemented

2 5 5 5

Not applicable - 9 4 2



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Financial Markets (8)Compliance With IOSCO

Despite high compliance, some gaps remainEquities Market: Responsibilities and operational

independence of regulator; inspection and surveillance

powers; capital and prudential requirements for market

intermediaries

Foreign Exchange Market: Operational independence and

accountability of regulator; co-operation and detection of

manipulation and unfair trading practices

G-Sec markets: Operational independence and accountability

of regulator; home-host co-operation; disclosure of financial

results

Money markets: Operational independence; regulatory co-

operation with foreign regulator


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F. Financial Infrastructure


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Financial Infrastructure (1)Regulatory Infrastructure

Multiple roles of regulators

Consistent with financial development

Needs effective coordination

Principles vs. Rules-based: complementary

Develop supervision of financial conglomerates

Legislation, a new Act?

Develop Self -Regulatory Organisations?

Regulatory independence

Panels have raised some issues

But CFSA considered adequate

Fi i l I f t t (2)


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Financial Infrastructure (2)Markets and Liquidity

Large capital movementsVolatility in overnight rates

Strengthen government cash management

Asset liability management of banks

Issues related to market integrity

participatory notes

Term liquidity facility not required at this

stage

Financial Infrastructure (3)


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Financial Infrastructure (3)Accounting and Auditing

More autonomy for Accounting StandardsBoard

Need to develop sector-specific guidance

Issues in auditing about convergence withISAs

Need to give functional independence to

AASB

Fi i l I f t t (4)


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Financial Infrastructure (4)Payment and Settlement

Payment & Settlement Act of 2007 fills a

major gap

Sub-optimal utilisation of electronic payment

infrastructure

Delays in collection of outstation cheques

Financial resources with CCIL needstrengthening

Fi i l I f t t (5)


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Financial Infrastructure (5)Business Continuity Management

Ease of operations during crises

Areas for strengthening

Human Resources management

Business continuity processes of

vendors

Outsourcing risk

Succession planning


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Financial Infrastructure (6)Assessment of Bankruptcy Law Principles

Assessment NumberObserved 38

Broadly Observed 24

Partly Observed 12

Total 74Major Gaps:

Implementation of bankruptcy lawspoor- average 10 years to

complete liquidation proceedingsDoing Business Report- World

BankAmendment to the Companies Act still pendingSetting up of

NCLT

Issues relating to Competition Amendment Act, 2007

Lack of a Central Registry for recording security interests

Financial Infrastructure (7)


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Financial Infrastructure (7)Depositor Protection

Independence of Deposit Insurance and CreditGuarantee Corporation (DICGC)

(recommended by Advisory Panel)

Increase flat-rate premiumInvolvement of DICGC in resolution process-

delink settlement of DICGC claims from

liquidation process


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G. Transparency and

Development Issues

Transparency and Development Issues (1)


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Transparency and Development Issues (1)Assessment of Transparency in Monetary

and Financial Policies

Assessment Transparency inMonetary Policy

Transparency in FinancialPolicies

RBI SEBI IRDA

Observed 40 32 33 29

Broadly Observed 1 - - -

Partly Observed 3 4 - -

Not Observed - - - 1

Not Applicable 2 - 3 6

Major Gaps/Issues:

Need for review of legislations- overhaul of legislations not requiredOperational independence of RBI

Strengthening TACMPrequires ongoing review

Separation of debt management from monetary managementChairmans

dissent

Price index for measuring inflationWPI/CPI debate



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Transparency and Development Issues (2)Assessment of Fiscal Transparency

Assessment Centre StatesObserved 36 22

Broadly Observed 4 6

Partly Observed 5 15

Not Observed - 2

Significant improvement following FRBM Act and Fiscal ResponsibilityLegislations

Major Gaps/Issues:

Functional overlap by Central Government on issues relating to State Government

like health and agriculture

Mode of calculating FD does not capture off-budget items separatelyaugmented

FD required

Need for accrual-based accountingguarded approach



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Transparency and Development Issues (3)Assessment of Data Dissemination Standards

Assessment National

Accounts

WPI CPI-IW Government

FinanceStatistics

Monetary

Statistics

Balance of

Payments

Observed 6 15 18 9 22 19

Largely Observed 13 6 3 10 - 3

Largely Not

Observed

3 1 1 3 - -

Not Observed - - - - - -

Major Gaps:

Need for proper legal and institutional support for CSO

IIP data - need to adjust basket of commodities and weights assigned

Multiple agencies in collection of labour data

WPIoutdated weights



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Transparency and Development Issues (4)Making Financial Inclusion Work

Rangarajan Committee on financial inclusion

Exploit synergies between local and national levelfinancial institutions

Finance consumption and household expenditure

Scale-up IT initiatives

Biometric smart cards in rural areas

Development of mobile banking

Incentivise BCs

Urban poor

Dilute KYC norms


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Part III

Transparent Reporting


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H. Peer Reviewers Comments

P R i C t (1)


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Peer Reviewers Comments (1)

Financial Stability Assessment and Stress Testing

V. Sundararajan

Plausible shocks and vulnerabilities arising out ofdomestic macroeconomic and external sectors should besystemically linked to stress scenarios

Growing use of purchased funds need analysis of secondround contagion effects

Andrew Sheng

Creation of secondary mortgage market

Setting up of Government sponsored secondarymortgage vehicles

On-site examination process should be supplemented by aforensic follow the evolution of the product approach.



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Assessment of BCPEric Rosengren

Urgent need to improve co-ordination between regulatoryagencies

LoLR should have the ability to assess solvency and liquidityrisks facing institutions

Report should elaborate on aspects relating to CentralGovernments role in operation of PSBs whether it interfereswith the regulatory role of RBI

Corporate Governance and

Transparency in Monetary Policy

Sir Andrew Large Higher corporate governance standards for the unlisted sector

Mechanism to enable central bank to be adequately informed tohandle liquidity related events

Improvements in transparency would enhance central bankindependence



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Bankruptcy Laws

Thomas Baxter

Indian insolvency regime remains an enigma

Special Insolvency regime for banks complement accessto credit facilities of central bank and deposit insurance

Fiscal Transparency

Vito Tanzi

Better classification of expenditure central to fiscal policy

Relevant fiscal target should be GFD and not revenuedeficit

Relatively few countries have made a transition to accrualbased accounting



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Accounting and Auditing

Ian Mackintosh

Exercise caution while developing country specific

and sector specific accounting standards

Important to give functional independence to AASB

N.P. Sarda

Determining the role of the Quality Review Board toreview and improve the quality of audit service is

required


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I. CFSA and Advisory Panels

Some Differences

CFSA and Advisory Panels


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CFSA and Advisory Panels Some Differences

Regulatory Independence

Panel view : Issues regarding independence of SEBI and IRDA

CFSA view: Regulatory independence adequate

Review of Legislation

Panel view : Review of RBI Act needed

CFSA view : Requires to be viewed in a more comprehensivemanner

Role of HLCCFM

Panel view : Further formalisation and institutionalisation

CFSA view: Not consistent with regulators autonomy

Prompt Corrective Action

Panel view : Appropriate time-frame required

CFSA view: Any rigidity in timeline unduly restrictive


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Part IV

Conclusions and Concerns

Conclusions and Concerns (1)


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Conclusions and Concerns (1)Summary of Assessment

Financial SectorHas expanded; acquiredgreater depth and vibrancy

Macro economyShort-term - Uncertainty;

Medium-term - high growth sustainableBanksHealthy and Robust

Financial MarketsResilient and fairly

liquidFinancial InfrastructureRobust

TransparencySignificant improvements



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Conclusions and Concerns (2)Main Concerns

Macro economyFiscal Deficit

Agricultural Growth

Susceptibility to international commodity price movements

Institutions

Emerging liquidity concerns

Corporate governance in co-operative sector

Health of rural co-operatives

Funding constraints for NBFCs

Lack of timely data to gauge household indebtedness Stress Testing

Lack of database, techniques and capacity to conductappropriate systemic stress tests taking into accountsectoral interlinkages as also contagion risk



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Financial Markets

Risk of contagion

Development of an appropriate risk free yieldcurve

Corporate bond markets

Issues relating to derivativesknowledge

concentration and capacity building

Transparency

Some issues in fiscal transparency; Need to

stren then data collection a encies



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Delay in bankruptcy proceedings and credit dispute resolutionTime taken for winding up proceedings is highest in the

world

Improvement in effective enforcement of creditor rightsrequired

Faster resolution of stressed assets of financialintermediaries

Regulation of financial conglomerates and holding companies

Role of SROs

Regulatory co-operationparticularly cross border

Management of capital account

Deficiency in retail payment systems

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