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Understanding Finance
Sector
in
India
Dr. Prashant S. Desai
Assistant Professor in Law,
National Law
School
of
India
University,
Bangalore‐560 072.
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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
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What is
finance
sector?
• Interestingly the term ‘finance sector’ is
not ‘technically’
or
‘legally’
defined
• There are few explanations
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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”
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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”
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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”
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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.,
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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
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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
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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.,
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• 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.
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• 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.
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• 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.
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• 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
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• “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
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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
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Mutual
Fund
Operation
Flow
Chart
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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
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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
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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
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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
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•
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
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• 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
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• 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.
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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.
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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
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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.
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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.
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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.
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The
new
emerging
challenge• Globalizing trend (reduction of
geographical boundaries)
has
further
added to the complexity of the
regulation
of
financial
sector
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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
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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
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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
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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.
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•
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.
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•
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;
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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.”
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• 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.
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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.
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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.
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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
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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.
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• 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
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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
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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.
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• 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
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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
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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.
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• 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).
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• 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.
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• 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.
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• 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.
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•
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
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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
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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
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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.
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• 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.
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• 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
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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.
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• 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
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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.
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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
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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
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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.
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• 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.
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• 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
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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.