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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
Financial Markets (7)
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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
Financial Markets (8)
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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
Transparency and Development Issues (2)
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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
Transparency and Development Issues (3)
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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
Transparency and Development Issues (4)
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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.
Peer Reviewers Comments (2)
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Peer Reviewers Comments (2)
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
Peer Reviewers Comments (3)
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Peer Reviewers Comments (3)
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
Peer Reviewers Comments (4)
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Peer Reviewers Comments (4)
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
Conclusions and Concerns (2)
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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
Conclusions and Concerns (3)
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Conclusions and Concerns (3)Main Concerns
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
Conclusions and Concerns (4)
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Conclusions and Concerns (4)Main Concerns
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