## _cr1308 ## Source details **Canonical URL:** [_cr1308](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr1308.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr1308.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr1308.pdf.json) --- ### Executive Summary — Progress, Vulnerabilities, and Near-term Stability - India made "remarkable progress" toward a stable financial system since early 1990s liberalization; legal, regulatory, and supervisory frameworks have improved. (¶1) - The system weathered the global financial crisis well due to strong balance sheets, profitability, robust regulation, and timely liquidity and demand-support actions. (¶1) - Key structural vulnerabilities: - Prominent state role: state ownership of large financial institutions, captive government financing, directed credit, activity controls, and foreign capital restrictions contribute to fiscal contingent liabilities and capital misallocation risk. (¶2) - Increasing complexity: growing interlinkages across markets, institutions, and borders; rise of conglomerate and mixed conglomerate structures. (¶2) - Near-term assessment: vulnerabilities manageable in the near term; pressures on asset quality from prior credit expansion and recent slowdown, group concentrations troubling at some banks, and risk of capital flow reversals exist. (¶3) - Reserve buffers: stress tests indicate substantial buffers of high quality assets (cash and government paper) and central bank facilities can be relied on. (¶3) ### Macroeconomic Performance and External Financing - GDP and growth: - GDP growth reached "8.4 percent" in 2010/11. - IMF projects GDP growth to moderate to "6.8 percent" in 2011/12. - Scenario GDP paths (percent): - Baseline - September: 2010/11 9.9; 2011/12 7.5; 2012/13 7.9; 2013/14 8.1; 2014/15 8.1; 2015/16 8.1. - Medium risk: 2010/11 9.9; 2011/12 5.1; 2012/13 5.5; 2013/14 6.5; 2014/15 7.0; 2015/16 7.5. - Severe risk: 2010/11 9.9; 2011/12 3.8; 2012/13 4.7; 2013/14 5.8; 2014/15 6.5; 2015/16 7.5. - External balances and flows: - Current account deficit averaged around "2.5 percent of GDP" in recent years. - External commercial borrowing by corporates broadly stable at around "5 percent of GDP". - Cross-border banking claims on India by end-September 2011: U.S. banks "3.7 percent" of GDP; U.K. banks "4.2 percent" of GDP; European (ex U.K.) banks "4.1 percent" of GDP. Direct bank exposure to Europe under "1 percent" of GDP. - Policy stance and suggested liberalizations: - Careful capital account liberalization; increase FII quotas on local currency bond investments, allow more bank borrowing abroad flexibility, and uniform treatment of nonresidents. ### Financial System Structure and Key Statistics - Overall financial system assets: "140 percent of GDP" as of end-March 2010. - Sector composition: - Commercial banks: "55 percent" of total financial assets. - Pension coverage: "12 percent" of the working population. - Public ownership: - Majority publicly-owned banks account for "three quarters" of banking system assets. - About "69 percent" of insurance premiums and "80 percent" of insurance assets by public insurers. - Largest public life insurer and public provident fund AUM: "US$200 billion" and "US$70 billion", respectively. - Foreign participation: - Foreign banks: "7 percent" of banking system assets. - Insurance foreign joint venture cap: "26 percent" of equity. - Financial conglomerates: "12" exist; bank-led conglomerates comprise over "20 percent" of financial system assets and "35 percent" of commercial banks’ assets. - Capital markets: - Equity market capitalization: "87 per cent of GDP"; over "5,000" companies listed on BSE. - Top 10 companies represent "31 percent" of market capitalization. ### Banking Soundness, Performance, and Vulnerabilities - Capitalization and profitability: - Banks’ CRAR averaged "over 14 percent" in March 2011. - Private banks generally have higher capital ratios and better earnings and cost efficiency than public banks. - Capital needs and public bank dependence: - Banks will need more capital to support credit growth and meet Basel III. - Government announced in October "US$5 billion" for recapitalizing public banks during 2011/12. - Asset quality and provisioning: - NPA ratio: declined from "5.2 percent" in 2005 to "2.4 percent" in 2008; asset quality declined more recently, notably in priority sectors and infrastructure. - RBI required banks to increase provisioning to "70 percent" of end-September 2010 NPAs—only private banks have reached this. - Concentration and funding: - Top group exposures: "30 percent" of capital on average (June 2011). - Prudential single group concentration allowed up to "55 percent" of a bank’s capital (existing rule). - Retail deposits > "50 percent" of bank liabilities; wholesale deposits "10 percent". - External borrowing caps for banks: higher of "50 percent of Tier 1 capital" or "US$10 million"; external borrowing amounted to "2.8 percent" (public banks) and "7.3 percent" (domestic private banks) of total liabilities. - CRR set at "5.5 percent"; SLR set at "24 percent"; most government securities held for SLR not available for liquidity in normal times. ### Stress Tests, Scenarios, and Capital Needs - Macro stress test scenarios: - Scenario 1: Annual GDP growth "7 percent" with credit growth "11.5 percent" per year. - Scenario 2: Annual GDP growth "8.5 percent" with credit growth "14 percent" per year. - Scenario 3: Annual GDP growth "10 percent" with credit growth "17 percent" per year. - Sample and modeling: - Sample: "30 banks" covering over "90 percent" of commercial banking system assets; subset "21 Public Sector Banks" represent "81 percent" of assets in sample. - Loan funding: loan growth funded by deposit growth with loan-to-deposit ratios maintained around "70 percent". - Replacement of hybrid Tier 1 securities under Basel III: commercial banks need additional "US$7.8 billion", of which "US$6.9 billion" would be needed by public banks. - Tier 1 hybrid composition: India "8 percent" of Tier 1, regional peer average "6.5 percent". - Main quantifiable results (preserve figures exactly as reported): - All 30 Banks: - With earnings generation (mean): Scenario 1 = "10"; Scenario 2 = "14"; Scenario 3 = "23" - With earnings generation (low): Scenario 1 = "13"; Scenario 2 = "17"; Scenario 3 = "26" - Additional Equity Capital needed (US$ million): Scenario 1 = "5,200"; Scenario 2 = "19,635"; Scenario 3 = "50,564" - Additional Equity Capital needed (percent of GDP): Scenario 1 = "0.3"; Scenario 2 = "1.2"; Scenario 3 = "3.1" - 21 Public Sector Banks (81 percent of assets in sample): - With earnings generation (mean): Scenario 1 = "9"; Scenario 2 = "13"; Scenario 3 = "20" - With earnings generation (low): Scenario 1 = "12"; Scenario 2 = "14"; Scenario 3 = "21" - Additional Equity Capital needed with mean earnings (US$ million): Scenario 1 = "5,134"; Scenario 2 = "19,370"; Scenario 3 = "49,886" - Additional Equity Capital needed (percent of GDP): Scenario 1 = "0.3"; Scenario 2 = "1.2"; Scenario 3 = "3.1" - Percentage of funds which can be raised from the private sector allowing for govt.'s shareholding to be reduced to 51 percent: Scenario 1 = "65%"; Scenario 2 = "54%"; Scenario 3 = "51%" - Mid-growth (Scenario 2) headline: - "14 banks" expected to fall short of Basel III minimum common equity requirement with a capital buffer at "7 percent"; "13" are public banks. - Average additional capital needs: around "US$19.6 billion". - High-growth (Scenario 3) headline: - Capital needs around "US$50.6 billion"; "23 banks" would need additional capital, of which "20" are public banks. - If growth between "7 percent to 10 percent" per year till 2019: - Between "9 to 20" public banks out of "21" could fall short of Basel III requirements. - Additional capital needs range between "US$5.1 billion to US$49.9 billion". - Between "51 percent and 65 percent" of these needs could be sourced from private sector while allowing government stake reduced to "51 percent". ### Stress Test Shocks and Contagion - Credit risk shocks used: increases in NPAs up to "150 percent"; reclassification of "15 percent" of restructured loans; uniform downgrade by one notch; increase in probabilities of default by "25 percent". - Interest rate shocks: parallel shifts of INR yield curve "250 bps"; steepening "100 bps"; inversion with two-year rates up "250 bps" and 10-year rates up "100 bps". - FX shocks: "10 percent" and "15 percent" INR depreciation or appreciation in "30 days"; reverse test for Tier 1 capital to reach "3 percent" in "60 days". - Equity shock: equity price index drop "40 percent" in "30 days". - Liquidity shocks: "30-day" deposit and wholesale funding withdrawal "10 percent"; "5-day" deposit (wholesale funding) withdrawal of "5 (3) percent". - Contagion analysis: Network analysis by RBI indicates failure of two most connected net borrowing banks would spread into five contagion stages; six banks' Tier 1 ratio would fall below "6 percent", three banks to "6–9 percent", remainder above "9 percent". ### Regulatory and Supervisory Gaps — Cross-sector Findings and Recommendations - General gaps: - Lack of de jure independence across regulators; state relationships with supervised entities challenge independence. (¶4) - Consolidated supervision framework for financial conglomerates still developing; lead supervisor needs legal backing. (¶4, ¶46) - Prudential gaps: large exposures and related-party lending regimes in banks; valuation and solvency requirements in insurance. (¶4) - Securities regulation: need better monitoring of issuer reporting, auditing, accounting and stronger criminal enforcement mechanisms. (¶4) - Clearing and settlement legal framework needs strengthening for corporate securities, CCP liquidity risk management, and regulatory coordination. (¶4, 171) - Supervisory effectiveness: augment resources, retain skilled personnel, reconsider staff rotation, and implement inspector certification. (¶36) - Specific recommendations with priority/timeframe (selected from FSAP Update Table 1): - Enhance RBI monitoring of corporate indebtedness, refinancing risk, and foreign exchange exposures — Priority: "H", Time Frame: "S". (¶13) - Improve performance and financial strength of public financial institutions; subject them to full supervision and regulation — Priority: "H", Time Frame: "M". (¶20) - Strengthen oversight of banks’ overseas operations through MOUs, onsite inspections, and supervisory colleges — Priority: "H", Time Frame: "M". (¶34) - Enhance formal statutory basis for regulator autonomy — Priority: "M", Time Frame: "M". (¶34, 40, 44) - Tighten definition of large and related party concentration and gradually reduce exposure limits — Priority: "H", Time Frame: "M". (¶34) - Develop programs to accredit and retain skilled supervisors — Priority: "H", Time Frame: "M". (¶36) - Continue to strengthen coordination and information sharing among domestic supervisors via MOUs and formal frameworks — Priority: "H", Time Frame: "S". (¶46, 67) - Provide a lead supervisor with legal backing for consolidated supervision including authority to inspect subsidiaries and affiliates — Priority: "H", Time Frame: "S". (¶46) - Expedite passage of Insurance Law (Amendment) Bill — Priority: "H", Time Frame: "S". (¶41) - Implement corrective action ladder for insurers based on solvency ratios — Priority: "H", Time Frame: "S". (¶43) - Enact legislation formalizing the New Pension Scheme and PFRDA — Priority: "H", Time Frame: "S". (¶32) ### Reserve Bank of India Role, Conflicts, and Liquidity Framework - Multiple RBI roles create conflicts: monetary authority, bank regulator, and government debt manager; RBI officers sit on public bank Boards while supervising them. (¶5) - Preferable for government to appoint independent Board members not from RBI. (¶5) - RBI involvement may have contributed to larger bank holdings of government debt and use of banking system to meet priority sector needs. (¶5) - Systemic liquidity management: - RBI revised operational framework in early 2011 to move market to structural deficit and guide short-term rates via OMO; relies on stock of government securities usable as collateral. (36) - CRR and SLR act as precautionary buffers but impose costs: CRR "5.5 percent"; SLR "24 percent". High SLR and HTM holdings hinder yield curve development, monetary transmission, and expose banks to interest rate risk. (36) - Recommendation: announce timetable to gradually reduce SLR and review HTM usage in line with global prudential liquidity requirements. (¶51) ### Crisis Management, Resolution, and Safety Nets - Resolution powers: - RBI has broad resolution authority for private banks but stronger powers for carve-outs and bridge/purchase & assumption transactions would be desirable; moratoria should be optional. (¶53) - Legal framework for public banks less specific; RBI cannot disempower a public bank to cease operations. (36) - Deposit insurance (DICGC): - DICGC established in "1962" as RBI subsidiary; acts as pay-box with funding role in resolution. (56) - Delays in depositor payout: compensation on average takes close to "a year". - Insured deposits represent "35 percent" of total deposits by value. - Reserve ratio was "1.4 percent" of insured deposits as of end March 2012. - Emergency back-up funding from RBI limited to "INR 50 million"—appears inadequate. - Recommendations: give DICGC greater role in appointing liquidators, eliminate set off practice, provide up-to-date single depositor view, strengthen funding and access to supplementary rapid back-up funding from RBI or government. (56) ### Capital Markets, Infrastructure Financing, and Financial Markets Infrastructure - Capital market development measures taken: - Simplified bond listing/disclosure, trade reporting, improved clearing/settlement, removed tax deduction at source for listed corporate bonds for residents, uniform day count convention, RBI guidelines for bilateral corporate bond repos, enhanced FII limits, reduced withholding tax for infrastructure funds. (56) - FIIs hold "5 percent" of corporate bond holdings; 2011 budget raised FII corporate bond limit to "US$40 billion" with "US$25 billion" for infrastructure bonds and a "1-year" lock-in for part; withholding tax reduced to "5 percent" for infrastructure investments. - Further liberalization recommended to encourage foreign participation. (56) - Infrastructure financing challenges and recommendations: - Government's 12th Plan (2012/17) calls for about "US$1 trillion" investment with private sector contributing at least "half". - Commercial banks have been main private lenders but cannot continue prudently; shallow corporate bond market and institutional investment restrictions limit refinancing. - Short-term mitigation: share risk between private/public sponsors; design credit enhancement mechanisms. - Financing model change recommended: 'originate-carry-refinance' with higher construction spreads and pre-arranged refinancing by long-term institutional investors or capital markets; RBI could accelerate reduction in single borrower limits for infrastructure. (56) - Clearing and settlement infrastructure: - RTGS implemented in "2004" for large-value settlement, including government securities cash legs. - Main operators: CCIL (government securities, money market, FX), PDO (RBI) as CSD for government securities, NSCCL, BSE, ICCL, MCX-SX CCL for CCP functions; NSDL and CDSL as CSDs for corporate securities. - Recommendations: strengthen legal backing for finality and netting, enhance CCP liquidity risk management, consider central bank settlement model for corporate securities and derivatives, formalize cooperation between RBI and SEBI, and establish crisis/default testing. (171, Annex Table 13) ### Insolvency, Secured Transactions, and Debt Recovery - Corporate insolvency shortcomings: - Need comprehensive modern insolvency law with viable reorganization regime and stronger supporting institutions. (¶69) - DRTs: subject to delays up to "four years"; operate like inefficient courts. - SARFAESI: improved out-of-court enforcement for banks and HFCs but limited coverage; enforcement speed and registration timeliness need improvement. - Central Registry under SARFAESI not effective; multiple registries exist and registration is not dispositive—creditors must search several registries. - Recommendation: enact unified insolvency law covering corporate and unincorporated businesses or at minimum a more comprehensive personal insolvency law for small businesses. (56) ### Nonbank Financial Companies, Cooperative Banks, and Other Vulnerabilities - NBFCs: - Some NBFCs systemically important; deposit-taking NBFC issuance halted; definition of systemic NBFCs currently asset threshold "INR 1 billion" pending refinement. (36) - Recommendation: focus regulation on systemically important NBFCs; maintain minimum reporting even for de-registered NBFCs. - Cooperative banks: - Regional Rural Banks (RRBs) gross NPA high (RRBs nearly double commercial banks, some regions close to "10 percent"). - Urban Cooperative Banks: asset quality and capital weak; many rural cooperative banks with losses and very high NPAs. - Since 2005, "230" urban cooperative banks merged ("95") or liquidated ("135"). (36) ### Insurance Sector Assessment and Action Plan - Market structure and metrics: - Life insurance assets to GDP: "16.8 percent" (84 percent contributed by LIC). (110) - Establishment capital: specialist direct writer "INR 1 billion"; reinsurer minimum "INR 2 billion". (110) - IRDA requires insurers to maintain minimum capital and solvency; in practice maintain "150 percent" of statutory solvency amount. (110) - Main issues and recommendations: - Insurance Amendment Bill (2008) pending; passage urged to address prudential matters, intervention tools, independence, fines, facilitation of mergers/portfolio transfers, reinsurer treatment, and clarity of supervisory roles. (110, Annex Table 8) - Implement corrective action ladder tied to solvency ratios and formalize enforcement toolkit and fines. (¶41, Annex Table 8) - Improve actuarial standards and certification, especially for non-life claims; establish Actuarial Standards Board and specialized certification. (36, 110) - Valuation practices: fixed income valued at amortized cost regardless of market value—may contravene Insurance Act in high rate environments; align valuation with law and produce actuarial standards. (36, 110) - Facilitate exit of weak insurers via merger and portfolio transfer mechanisms. (110) - Recommended action highlights (Annex Table 8): - ICP 3: pass Insurance Amendment Bill to ensure IRDA independence and stronger direct powers. - ICP 15: formalize enforcement via a Supervisory Guide/Ladder of Intervention; update fines to current values. - ICP 20 (non-life liabilities): provide guidance for long-tail provisions and certify non-life appointed actuaries. - ICP 27: continue development of fraud control systems. ### Securities Markets (SEBI) Assessment and Recommended Actions - Main supervisory strengths: - SEBI has broad regulatory, licensing, investigation, supervision, and enforcement powers; has built robust market surveillance and enforcement against market manipulation and insider trading. (36, 145) - As of June 2011: "5,025" listed companies on BSE; market capitalization "87 percent of GDP"; top 10 companies "31 percent" of market cap. (145) - Key gaps and reforms: - Improve supervision of intermediaries, fund managers, mutual funds; strengthen mechanisms to ensure issuer compliance with reporting, auditing, and accounting; consider stricter independence protections in law (Board removal provisions). (36, 145) - Enhance onsite inspection program and criminal enforcement capacity; consider private right of action and improved access to phone records (subject to judicial approval). (Appendix Table 10) - Coordination: strengthen coordination with MCA and RSEs for prospectus review, periodic reporting, and enforcement. (Appendix Table 10) - Accounting: finalize implementation of IFRS-equivalent standards by proposed timetable (noted target in content: "April 2013" for convergence in banking context). (145, Annex) - Market infrastructure: - Derivatives turnover substantially higher than cash equity turnover; index options largest share "45.5 percent". - Clearing and settlement CCPs and CSDs: NSCCL, ICCL, CCIL, NSDL, CDSL; recommendations include enhancing legal finality/netting, stress testing, liquidity management, and considering move to central bank settlement model for corporate securities to reduce settlement bank concentration risk. (171, Annex Table 13) ### AML/CFT, Market Integrity, and Risk Assessment - AML/CFT framework: - Prevention of Money Laundering Act, "2002" is the legislative foundation; regulators issued guidelines for currency transaction reports and suspicious transaction reporting. (82) - Gaps: unresolved legal issues on predicate offences, absence of money laundering convictions, need to broaden customer due diligence, beneficial ownership measures, and extend PMLA to designated nonfinancial businesses and professions. - Recommendations include enhancing supervisory sanction regimes and ensuring India Post implements AML/CFT requirements. (56, 171) - Risk Assessment Matrix (selected threats and staff assessments): - Continued high or accelerating inflation — Staff assessment: "MEDIUM"; Expected impact: "MEDIUM to HIGH". - Slowdown in economic growth — Staff assessment: "MEDIUM"; Expected impact: "MEDIUM to HIGH". - Sharp reversal of capital flows — Staff assessment: "MEDIUM"; Expected impact: "MEDIUM to HIGH". - Decline in real estate prices — Staff assessment: "MEDIUM"; Expected impact: "MEDIUM". ### Key Macro-Financial Indicators (selected exact figures) - Nominal GDP (billions of U.S. dollars): "1,684" - GDP per capita (U.S. dollars): "1,420" - Population (2010): Total (in billions): "1.21" - Real GDP fiscal-year growth (selected): - 2010/11: "8.4" - 2011/12: "6.8" - 2012/13 Prel./Est./Proj.: "7.0" - Wholesale prices (average): 2010/11 "9.6"; 2011/12 "8.7"; 2012/13 "7.2" - Gross reserves (US$ billions, end-period): 2012/13: "315.7" - Current account balance (US$ billions): 2012/13: "-56.3" - General government debt (percent of GDP): 2012/13: "65.7" - Broad money y/y end-period: 2011/12 "31.1"; 2012/13 "18.2" - Credit to commercial sector y/y end-period: 2010/11 "21.3"; 2011/12 "18.8" - 10-year government bond yield end-period 2010/11: "8.0" *Source: Executive Summary and staff report excerpts, IMF Financial Sector Assessment Program Update (India).* ### Executive Summary ...................................................................................................... ### Executive Summary ### Progress and System Overview - India has made remarkable progress toward developing a stable financial system since liberalization in the early 1990s, accompanied by steady improvements in the legal, regulatory, and supervisory framework. (¶1) - The Indian economy and its financial system weathered the global financial crisis well due to strong balance sheets and profitability entering the crisis, a robust regulatory framework, and timely actions to counter pressures on liquidity, the supply of credit, and aggregate demand. (¶1) ### Key Vulnerabilities and Structural Issues - Prominent role of the state in the financial sector creates risks: - State ownership of large financial institutions, captive government financing, directed credit to priority sectors, tight activity controls, and restrictions on foreign capital contribute to a build-up of fiscal contingent liabilities and risk of capital misallocation. (¶2) - Recommendation: Gradually reduce mandatory holdings of government securities by financial institutions and allow greater access to private (domestic and foreign) sources of capital to improve intermediation toward productive activities. (¶2) - Increasing complexity of the system: - Interlinkages across markets and institutions and across borders are growing; conglomerate and mixed conglomerate structures are on the rise. Continued regulatory improvements and strengthened supervision and financial stability frameworks are required. (¶2) ### Near-term Stability Assessment - Despite risks, vulnerabilities are manageable in the near term. (¶3) - A sharp credit expansion followed by a more recent economic slowdown is pressuring banks’ asset quality, especially in infrastructure and priority sector lending; group concentrations are troubling at some banks. (¶3) - Risk of reversal of capital flows and renewed liquidity pressures similar to 2008 exists. (¶3) - Stress tests indicate banks’ substantial buffers of high quality assets (cash and holdings of government paper) should enable them to deal with such pressures, including recourse to central bank facilities. (¶3) ### Regulatory and Supervisory Gaps - Oversight largely complies with international standards but gaps remain. (¶4) - A common issue across sectors is lack of de jure independence; relationships with state-owned supervised entities can challenge independence. (¶4) - Consolidated supervision framework for financial conglomerates is still being developed. (¶4) - Prudential gaps include large exposures and related-party lending regimes in banks, and valuation and solvency requirements in insurance. (¶4) - Securities regulation needs better monitoring of compliance with reporting, auditing, and accounting requirements for issuers and stronger mechanisms for pursuing criminal enforcement. (¶4) - Securities clearing and settlement improvements needed in legal framework for corporate securities settlement, liquidity risk management for central counterparties (CCPs), and regulatory coordination. (¶4) - Supervisory effectiveness needs enhancement via augmented resources, skilled personnel, and revised staffing policies. (¶4) - Regulators must have clear mandates focusing on safety and soundness, risk management, disclosure, and market conduct; supervisory involvement in credit and asset allocation decisions should be avoided. (¶4) ### Reserve Bank of India (RBI) Role and Conflicts - Multiple roles of RBI create potential conflicts: RBI officers sit on Boards of public banks while RBI supervises those banks. (¶5) - Preferable for government to appoint well-qualified, independent Board members not from RBI. (¶5) - RBI’s roles as monetary authority, bank regulator, and government debt manager may have led to requiring banks to hold larger holdings of government debt than prudentially necessary. (¶5) - Using the banking system to meet priority sector needs may conflict with RBI’s supervisory role. (¶5) ### Public Ownership of Banks - Given commitment to retain public sector character of state-owned banks, government needs to manage ownership to be compatible with prudent financing of a rapidly growing economy. (¶6) - Banks need flexibility to attract talent, innovate, enhance risk management, and build capital. Public ownership should not impose obligations that limit competitiveness and soundness. (¶6) ### Crisis Management and Resolution - More focus needed on crisis management structures and planning. (¶7) - RBI has broad resolution authority, but stronger powers to conduct carve-outs and more attention to crisis preparedness would be desirable. (¶7) - Resolution powers and contingency planning for insurance companies and the payment system need strengthening. (¶7) - Past approach of absorbing weak banks into stronger ones may be infeasible given fiscal constraints and absence of suitable acquirers; alternative approaches may be required. (¶7) - Effectiveness of the deposit insurance scheme can be bolstered by granting powers to appoint liquidators and strengthening funding. (¶7) ### Capital Markets and Infrastructure Financing - Authorities have taken steps to promote fixed income markets but further measures are desirable. (¶8) - Gradually reducing the Statutory Liquidity Ratio (SLR) in line with evolving international liquidity requirements would support deeper capital markets, systemic liquidity management, and monetary transmission. (¶8) - Greater use of capital markets to refinance infrastructure loans would help alleviate pressures on public banks, which are main lenders to the infrastructure sector. (¶8) ### Insolvency and Secured Transactions - Corporate insolvency and secured transactions frameworks have significant shortcomings. (¶9) - Need a comprehensive and modern insolvency law with a viable reorganization regime and stronger supporting institutions. (¶9) - SARFAESI has provided some out-of-court enforcement but timeliness and credit registry provisions need improvement and coverage should be extended. (¶9) ### Financial Inclusion and Private Initiative - Authorities’ commitment to financial inclusion could be enhanced by providing more room for private initiative and competition. (¶10) - Current initiatives tend to be prescriptive and may discourage market players from seeking cost-effective and sustainable ways to reach the underserved. (¶10) - Passage of draft legislation to create legal certainty for microfinance institutions should be a high priority. (¶10) - RBI should continue to open up space for nonbank payment service providers. (¶10) ### FSAP Update: Main Recommendations (Table 1) - Addressing system-wide risks - Enhance RBI monitoring of corporate indebtedness, refinancing risk, and foreign exchange exposures. (¶13) — Priority: H, Time Frame: S - Improve the performance and financial strength of public financial institutions and subject them to full supervision and regulation. (¶20) — Priority: H, Time Frame: M - Financial sector oversight - Strengthen oversight of banks’ overseas operations through MOUs with host countries for information-sharing, onsite inspection programs, and supervisory colleges. (¶34) — Priority: H, Time Frame: M - Enhance formal statutory basis for the autonomy of regulators in carrying out their regulatory and supervisory functions. (¶34, 40, 44) — Priority: M, Time Frame: M - Tighten the definition of large and related party concentration (short-term) and gradually reduce exposure limits to make them more consistent with international practices. (¶34) — Priority: H, Time Frame: M - Enhance specialized expertise in supervision by developing programs to accredit and retain skilled supervisors. (¶36) — Priority: H, Time Frame: M - Continue to strengthen coordination and information sharing among domestic supervisors through MOUs and formal frameworks to avoid regulatory gaps, identify emerging risks, and facilitate crisis response. (¶46, 67) — Priority: H, Time Frame: S - Provide a lead supervisor with legal backing for conducting consolidated supervision including authority to inspect subsidiaries and affiliates. (¶46) — Priority: H, Time Frame: S - Expedite passage of Insurance Law (Amendment) Bill. (¶41) — Priority: H, Time Frame: S - Implement corrective action ladder for insurers based on solvency ratios. (¶43) — Priority: H, Time Frame: S - Enact legislation formalizing the New Pension Scheme and the Pension Fund Regulatory and Development Authority. (¶32) — Priority: H, Time Frame: S - Systemic liquidity, crisis management, and safety nets - Announce a timetable for the gradual reduction in the SLR and review the use of the hold-to-maturity (HTM) category, taking account of emerging global prudential liquidity requirements. (¶51) — Priority: M, Time Frame: M - Strengthen resolution tools by granting stronger powers to supervisors to resolve nonviable entities in an orderly fashion. (¶53) — Priority: H, Time Frame: M - Develop and periodically test arrangements to deal with a major disruption to the financial system. (¶54, 66) — Priority: H, Time Frame: M - Broadening markets and services - Ease investment directives and limits to encourage investments in corporate and infrastructure bonds by institutional investors. (¶33, 62) — Priority: M, Time Frame: M - Consider further easing of restrictions on bond market investments by foreign institutional investors (FIIs). (¶59) — Priority: M, Time Frame: M - Financial markets infrastructure - Require CCPs to strengthen liquidity risk management procedures to enable them to cover losses in the event of the failure of a major participant. (¶66) — Priority: H, Time Frame: M - Consider replacing the commercial bank settlement model for corporate securities and derivatives with a central bank settlement model. (¶66) — Priority: M, Time Frame: M - Enact comprehensive modern corporate insolvency law and upgrade SARFAESI and existing laws governing insolvencies for unincorporated businesses. (¶69) — Priority: M, Time Frame: M *Source: Executive Summary, IMF Financial Sector Assessment Program Update (India).* ### 11. India recovered quickly from global market turbulence in 2008/09 but growth ### 11. India recovered quickly from global market turbulence in 2008/09 but growth has recently slowed ### Macroeconomic performance and near-term outlook - GDP growth reached 8.4 percent in 2010/11, largely driven by domestic demand. - IMF projects GDP growth to moderate to 6.8 percent in 2011/12. - Contributing factors to the slowdown: the uncertain global environment, governance concerns, and monetary tightening to address high inflation. ### External financing and capital flows - India’s current account deficit has averaged around 2.5 percent of GDP in recent years. - Main financing sources for the deficit: inflows from direct and institutional investors, corporate borrowing, and inflows into deposit accounts by nonresident Indians. - Policy stance: government has demonstrated a willingness to carefully lift capital account restrictions; examples of progress include increasing FII quotas on local currency bond investments. - Suggested further liberalizations noted in the text: increase ceilings on FII local currency bond investments, allow banks more flexibility in borrowing abroad, and treat all nonresidents uniformly. - External commercial borrowing by corporates has remained broadly stable at around 5 percent of GDP. - Cross-border banking claims: claims on India by U.S., U.K., and European (ex U.K.) banks were 3.7 percent, 4.2 percent, and 4.1 percent of India’s GDP, respectively, at end-September 2011; direct bank exposure to Europe is under 1 percent of GDP. ### Financial system structure and features - Overall financial system assets: 140 percent of GDP as of end-March 2010. - Sector composition: commercial banks account for 55 percent of total financial assets; insurance is the next largest. - Pension coverage: 12 percent of the working population. - Public ownership: - Majority publicly-owned banks account for three quarters of banking system assets. - About 69 percent of insurance premiums and 80 percent of insurance assets are accounted for by public insurers. - The public life insurance company and public provident fund are the two largest providers of funds to the Indian capital market, with US$200 billion and US$70 billion, respectively, in assets under management. - Foreign participation: - Foreign banks account for 7 percent of banking system assets; their expansion is restricted. - Insurance foreign joint ventures are limited to a maximum of 26 percent of equity. - Financial conglomerates: 12 exist — 6 bank-led, 3 insurance-led, 1 mutual fund group, 2 led by NBFCs. Bank financial conglomerates comprise over 20 percent of financial system assets and 35 percent of commercial banks’ assets. - Capital markets: - Market capitalization in equity markets amounts to 87 per cent of GDP, with over 5,000 companies listed on the Bombay Stock Exchange (BSE). - Market capitalization concentration: top 10 companies represent 31 percent of the total. - Money and equity markets are liquid; government bond market is large but relatively captive; corporate bond market is underdeveloped and dominated by AAA and AA issuance. ### Banking soundness, performance, and vulnerabilities - Capitalization and profitability: - Banks’ risk-weighted capital adequacy ratio (CRAR) averaged over 14 percent in March 2011. - Private banks generally have higher capital ratios and outperform public banks on earnings and cost efficiency. - Capital needs and policy implications: - Banks will need more capital to support credit growth and meet Basel III requirements. - Under current government policy, public banks are dependent on the government to provide the majority of any capital needs, which will put pressures on India’s fiscal position. - The government announced in October US$5 billion for recapitalizing public banks during 2011/12. - Asset quality and provisioning: - Nonperforming asset (NPA) ratio declined from 5.2 percent in 2005 to 2.4 percent in 2008, but asset quality declined more recently, notably for loans to priority sectors and infrastructure. - RBI required banks to increase provisioning to 70 percent of end-September 2010 NPAs, but only private banks have reached this amount. - Concentration risk: - Top group exposures were 30 percent of capital on average for the banking system as of June 2011. - Prudential rules allow single group concentrations up to 55 percent of a bank’s capital. - Funding and liquidity: - Retail deposits form over 50 percent of bank liabilities; wholesale deposits are 10 percent of liabilities. - External borrowing by banks is capped at the higher of 50 percent of Tier 1 capital or US$10 million, and amounted to 2.8 percent and 7.3 percent of total liabilities for public and domestic private banks, respectively. - Asset-liability maturity mismatches have increased (partly due to infrastructure lending) and raise susceptibility to liquidity pressures. - RBI uses CRR and SLR as precautionary buffers: CRR is set at 5.5 percent and SLR is set at 24 percent; most holdings of government securities are not available to meet liquid needs in normal times because they must be held continuously to meet SLR requirements. ### Stress tests and resilience - Scope: Stress tests covered 10 (bottom-up tests) to 60 (top-down tests) commercial banks (50 percent to 99 percent of the banking system). - Key test results: - Macro credit risk tests: the system overall is resilient to aggregate increases in credit risk; under scenarios the banking system remains adequately capitalized with an initial NPA increase declining as GDP recovers. - Liquidity stress tests: the banking system could withstand severe funding and market liquidity shocks (e.g., reversal of capital flows) under the assumption that the SLR is used in repos with RBI with a 5 percent haircut; tests included sudden, substantial withdrawals over five-day and 30-day periods, and maturity mismatch and roll-over risk. - Single-factor sensitivity analyses: credit risk (exposures to agriculture, power, telecommunications, and real estate) is the main source of vulnerability but appears manageable given high initial capital and profitability; only a few small banks would appear to need recapitalization. - Market risk shocks (interest rate, foreign exchange, equity price risks) have low impact largely due to regulations limiting maturity gaps, net foreign currency exposures, and equity market exposures. ### Policy recommendations and monitoring priorities (implicit in assessment) - Continue careful liberalization of capital account measures (raise FII quotas, increase bank borrowing flexibility abroad, uniform treatment of nonresidents). - Enhance RBI monitoring of corporate indebtedness, refinancing risk, and foreign exchange exposures because of their role as potential channels of contagion. - Address bank capital shortfalls—especially in public banks—to support credit growth and meet Basel III requirements, mindful of fiscal implications. - Reduce group concentration exposures toward prudent levels to limit the risk that a single large borrower could threaten a bank’s viability. - Strengthen provisioning practices and asset-quality recognition to ensure adequacy as NPAs rise. - Monitor and manage maturity mismatches and liquidity risk, including the availability and usability of SLR holdings in stress conditions. *Source: IMF staff report section titled “India recovered quickly from global market turbulence in 2008/09 but growth has recently slowed.”* ### 1. Annual GDP growth rate of 7 percent with credit growth of 11.5 percent per year. ### _cr1308 - 1. Annual GDP growth rate of 7 percent with credit growth of 11.5 percent per year. ### Scenarios and macro assumptions - Scenario 1: Annual GDP growth rate of 7 percent with credit growth of 11.5 percent per year. - Scenario 2: Annual GDP growth rate of 8.5 percent with credit growth of 14 percent per year. - Scenario 3: Annual GDP growth rate of 10 percent with credit growth of 17 percent per year. - Macro stress test framework: baseline and two adverse scenarios (medium and severe) with projections based on end FY2010/11 and the April 2011 World Economic Outlook. - Macro scenario GDP growth paths (percent): - Baseline - September: 2010/11 9.9; 2011/12 7.5; 2012/13 7.9; 2013/14 8.1; 2014/15 8.1; 2015/16 8.1. - Medium risk: 2010/11 9.9; 2011/12 5.1; 2012/13 5.5; 2013/14 6.5; 2014/15 7.0; 2015/16 7.5. - Severe risk: 2010/11 9.9; 2011/12 3.8; 2012/13 4.7; 2013/14 5.8; 2014/15 6.5; 2015/16 7.5. - WPI Inflation, Short-term (call) interest rate, and Export/GDP ratio scenario tables included in source (values preserved in original). ### Sample, modeling assumptions, and data - Sample: 30 banks, including public and private banks, covering over 90 percent of commercial banking system’s assets, using publicly available data. - Credit growth estimates premised on real GDP growth scenarios and projected inflation. - Capital generation derived from market estimates of Earnings per Share (which impute projections of income on a net basis after expected costs and other provisions, including NPA write-offs). - Loan growth funding assumption: loan growth is assumed to be funded by growth in deposits, with loan-to-deposit ratios being maintained at around 70 percent. - Replacement of hybrid Tier 1 securities as required under Basel III: commercial banks would need an additional US$7.8 billion, of which US$6.9 billion would be needed by public banks. - Note on Tier 1 hybrids: At 8 percent of Tier 1 capital, India’s composition of Tier 1 hybrid and preferred securities is higher than the region’s peer average of 6.5 percent. ### Main results: banks falling short of Basel III common equity (7.0 percent) and additional capital needs - Number of banks in sample: All 30 Banks and subset of 21 Public Sector Banks (81 percent of assets in sample). - Summary table (preserving exact figures from source): - All 30 Banks - With earnings generation (mean): Scenario 1 = 10; Scenario 2 = 14; Scenario 3 = 23 - With earnings generation (low): Scenario 1 = 13; Scenario 2 = 17; Scenario 3 = 26 - Additional Equity Capital needed (US$ million): Scenario 1 = 5,200; Scenario 2 = 19,635; Scenario 3 = 50,564 - Additional Equity Capital needed (percent of GDP): Scenario 1 = 0.3; Scenario 2 = 1.2; Scenario 3 = 3.1 - 21 Public Sector Banks (81 percent of assets in sample) - With earnings generation (mean): Scenario 1 = 9; Scenario 2 = 13; Scenario 3 = 20 - With earnings generation (low): Scenario 1 = 12; Scenario 2 = 14; Scenario 3 = 21 - Additional Equity Capital needed with mean earnings (US$ million): Scenario 1 = 5,134; Scenario 2 = 19,370; Scenario 3 = 49,886 - Additional Equity Capital needed (percent of GDP): Scenario 1 = 0.3; Scenario 2 = 1.2; Scenario 3 = 3.1 - Percentage of funds which can be raised from the private sector allowing for govt.'s shareholding to be reduced to 51 percent: Scenario 1 = 65%; Scenario 2 = 54%; Scenario 3 = 51% - Mid-growth scenario (average earnings generation): 14 banks expected to fall short of Basel III minimum common equity requirement with a capital buffer at 7 percent; of these 13 are public banks. - Average additional capital needs in mid-growth scenario: around US$19.6 billion. - High growth scenario: capital needs around US$50.6 billion and 23 banks would need additional capital, of which 20 are public banks. - If economic growth were to be between 7 percent to 10 percent per year till 2019: - Between 9 to 20 public banks out of 21 could fall short of Basel III common equity capital requirements with average earnings growth. - Additional capital needs range between US$5.1 billion to US$49.9 billion. - Between 51 percent and 65 percent of these additional capital needs could be sourced from the private sector while allowing for the government’s stake to be reduced to 51 percent. ### Stress test design, single-factor shocks, and calibration - Stress test horizons and calibration based on Indian historical data for the last 15 years and international experience. - Credit risk shocks: - Increases in NPAs by up to 150 percent. - Reclassification of 15 percent of restructured loans. - Uniform downgrade of all corporate borrowers by one notch. - Increase in probabilities of default by 25 percent. - Interest rate risk shocks: - Parallel downward and upward shift of the INR yield curve (250 bps). - Steepening of the curve (100 bps linearly spread between 15-day and over 25-year maturities). - Inversion of the curve (two-year rates up 250 bps and 10-year rates up 100 bps). - Foreign exchange risk shocks: - 10 percent and 15 percent depreciation of INR in 30 days. - 10 percent and 15 percent appreciation of INR in 30 days. - Reverse test to determine depreciation needed for Tier 1 capital to move down to 3 percent over 60 days. - Equity price risk: drop in the equity price index by 40 percent within a 30-day period. - Liquidity risk: - 30-day deposit and, separately, wholesale funding withdrawal of 10 percent. - 5-day deposit (wholesale funding) withdrawal of 5 (3) percent. ### Contagion analysis and systemic transmission - Network analysis by RBI: failure of the two most connected net borrowing banks would spread into five stages of contagion. - Contagion results (qualitative outcomes as presented): - Six banks (in black) would see their Tier 1 capital to risk weighted assets decline below 6 percent. - Three banks (in yellow) would see their capital fall to 6–9 percent. - Least affected banks (in green) would remain above 9 percent. - Figures in source showing evolution of System NPAs and CRAR under stress (aggregate NPA VAR and CRAR VAR series across dates). ### Other financial sector vulnerabilities and recommended policy actions - Non-commercial banks (regional rural banks and cooperative credit institutions): - Asset quality weak; regional rural banks’ gross NPA ratio on average nearly double that of commercial banks and in some regions close to 10 percent. - Cooperative credit institutions: urban cooperative banks’ profitability improved but asset quality and capital base remain weak; many rural cooperative banks weighed down by losses and very high NPA ratios. - Insurance sector: - Life insurance: Life Insurance Corporation of India (LIC) dominates; about half of private insurers making accounting losses. Policy actions suggested include: - Provide government administrative scope to phase out LIC’s government guarantee (or require LIC to price the guarantee into its products). - Raise the ceiling on foreign joint venture ownership from the current 26 percent of issued equity. - Facilitate exit of weak insurers using merger and portfolio transfer mechanisms. - Non-life insurance: four state-owned non-life insurers hold 60 percent of the market; two non-life insurers have dipped below IRDA’s minimum solvency requirement; regulatory forbearance has been granted for a limited period. Recommended remedial actions include actuarially correct pricing and improving pricing databases; consider establishing a centralized fraud database. - Pensions: - EPFO is the largest pension provider; latest published defined benefit fund valuation (2003/4) showed a deficit of about US$4.5 billion. - For three years, administered interest rate credited to members was a fixed 8.5 percent. - New Pension Scheme (NPS): defined contribution scheme began operations in January 2004; private individuals allowed since August 2008; NPS remains small but has growth potential. - Policy recommendations: formalize the NPS and its new regulator through enabling legislation; ensure passage of the enabling legislation submitted in 2005 for credibility. - Investment guideline concerns: current restrictions lead to heavy holdings of government and public sector securities (100 percent for EPFO and minimum 50 percent for civil service pensions), limiting investment in equities or corporate bonds. - Banking supervision and regulatory gaps: - Strengths: regulatory capital requirements in excess of Basel minima, conservative liquidity requirements, frequent onsite inspections, capital adequacy ratio requirement of at least 9 percent on both solo and consolidated basis under Basel II standardized approach. - Gaps and implementation constraints: - Material gaps in information flows with overseas supervisors; RBI has MOUs with only two and limited informal arrangements with others; overseas inspections not conducted regularly. - Several legal provisions limit de jure independence of RBI; measures suggested include removing provisions that allow government directions to RBI and specifying in law reasons for removal of the head of the central bank during his/her term. - Large exposure and connected lending regime needs tightening toward international practice (10 percent to 25 percent limits depending on borrower and collateral). - Supervisory governance concern: RBI employees acting as nominee directors on public bank boards blurs lines between supervisory role and board compliance guardian; RBI cannot force public banks to cease operations or remove officers/directors of a public bank, limiting supervisory effectiveness. *Italic: Source material drawn from the provided IMF content unit.* ### 36. Further steps to enhance the specialized expertise of supervisory personnel and ### 36. Further steps to enhance the specialized expertise of supervisory personnel and ### Strengthening supervisory expertise and techniques - Banks are increasing risk management sophistication and moving toward implementation of Basel II advanced approaches. - Recommended steps to improve supervisory capacity and effectiveness: - Reconsider the RBI’s staff rotation policy. - Introduce an “inspector certification” program. - Accelerate the phased implementation of a more risk-focused approach. - Require banks to implement a sound model validation policy. - Incorporate model testing in onsite inspections. - Structure onsite reviews of specific risk management areas. ### Nonbanking financial companies (NBFCs) - Several NBFCs are considered to be systemically important; RBI plans to focus regulatory efforts on them. - Current regulatory definitions and measures: - Prudential norms are prescribed for deposit-taking NBFCs. - A subset of non-deposit taking NBFCs is recognized by RBI to be systemically important (currently defined as those with assets above INR 1 billion pending elaboration of a more sophisticated approach). - Issuance of new licenses to deposit-taking NBFCs has ceased and RBI has encouraged those remaining to stop taking deposits. - Observations and recommendations: - Deposit-taking NBFCs have been shrinking in number and importance, but many non-deposit taking NBFCs, including some very large ones, regularly access public funds and are interconnected with the rest of the financial system including banks. - A recent RBI Working Group recommends encouraging smaller NBFCs to de-register, allowing RBI to focus regulatory efforts on those that are systemically important. - Authorities should maintain minimum data reporting even for NBFCs that de-register, so regulators can monitor developments and the risks being undertaken. ### Securities (SEBI) - Progress and strengths: - Significant progress in implementation of IOSCO Principles since the 2001 assessment. - SEBI has broad regulatory, licensing, investigation, supervision, and enforcement powers. - SEBI has developed robust regulations for issuers, collective investment schemes, brokers, portfolio managers, underwriters, and recognized regional stock exchanges (RSEs). - SEBI has built a robust market surveillance system and separate investigation and enforcement departments, translating into effective enforcement of unfair trading practices such as market manipulation and insider trading. - Medium-term considerations: - SEBI’s approach to capital requirements should become more risk-based. - Key supervisory challenges for SEBI: - Strengthen supervision of intermediaries, including fund managers and the mutual funds they administer. - Improve mechanisms to ensure compliance of issuers with reporting requirements. - Develop better mechanisms to ensure compliance with accounting and auditing requirements. - Institutional and resource decisions ahead: - Decisions required on the degree to which SEBI should continue to rely on exchanges for self-regulation. - Decisions required on whether SEBI alone should review information submitted by listed companies. - Decisions required on whether the Quality Review Board meets requirements for independent oversight of auditors. - These decisions will have an impact on SEBI’s resources. - De jure independence: - Legal framework limits the de jure independence of SEBI: Board members can be removed without cause and the government can supersede the Board and give SEBI directions on matters of policy. - Remedying these provisions would strengthen credibility of the supervisory process. - Criminal enforcement: - Strengthening criminal enforcement is a challenge outside SEBI’s control. - Past success: dedicated/designated criminal court tribunals for collective investment schemes. - Authorities could explore extending such arrangements to all types of securities offenses. ### Insurance (IRDA) - General assessment: - Insurance regulatory and supervisory infrastructure in India is relatively well developed. - IRDA has a clear mandate and is a leader among emerging markets in licensing, consumer protection, market oversight, and transparency. - Capacity needs: - IRDA needs to strengthen capacity to introduce a modern corrective action regime based on a risk-based approach to capital management. - Legislative reforms: - A number of deficiencies—prudential matters, intervention tools, and independence of the regulator—are addressed in the proposed 2008 Insurance Law (Amendment) Bill, which should be submitted to Parliament and enacted expeditiously. - Prudential application and actuarial standards: - Current practice relies on informal arrangements with appointed actuaries. - Fixed income securities are valued at amortized cost regardless of underlying market value, which in a high interest rate environment may result in assets valued above market price (a practice expressly prohibited by the Insurance Act). - Life insurers have adjusted discount rates to determine policy liabilities, but the practice should be consistent with official regulation. - The newly formed Actuarial Standards Board should produce relevant actuarial standards. - There should be a plan to introduce specialized certification of actuaries, particularly for non-life claims. - Intervention tools and sanctions: - Enforcement actions and sanctions open to IRDA tend to be light (negligible fines) or very heavy (suspension or cancellation of registration, amalgamation, winding up, etc.). - Fines have not been adjusted for decades and need to be brought up to current values. - IRDA has used a name and shame approach effectively, but enlarging the formal enforcement and sanctions toolkit via amending insurance legislation is desirable. - De jure independence: - In law, the Ministry of Finance has authority to appoint an administrator and take over the role of the supervisor, indicating a critical lack of independence in theory (if not practice). ### Cross-sectoral and system-wide oversight — System-wide oversight and the FSDC - India has long-standing use of macroprudential policy and has strengthened systemic oversight. - Institutional arrangements: - Financial Stability and Development Council (FSDC) created in December 2010. - FSDC mandate: systemic oversight, regulatory coordination, financial sector development, literacy, and inclusion. - FSDC is chaired by the Minister of Finance and comprises the RBI Governor and the heads of IRDA, SEBI, and PFRDA. - A subcommittee chaired by the RBI Governor acts as the operational arm of the FSDC. - Two working groups (on financial stability and on financial inclusion and financial literacy) provide coordination among regulators. - Clarification and strengthening recommended: - Clarify demarcation of responsibilities between FSDC and subcommittee (FSDC to play key role in crisis management; day-to-day regulatory coordination by subcommittee). - Spell out decision-making powers, information exchange arrangements, and reporting lines in detail in a MOU. - Strengthen the interface between RBI’s surveillance arrangements (notably the Financial Market Committee) and the FSDC and its subcommittee to support timely action in a crisis. ### Box 5 — India’s experience with macroprudential tools - Macroprudential policy objective: limit systemic risk in time (procyclicality) and cross-sectional (interconnectedness) dimensions. - India’s sectoral approach and tools used to counter cyclicality in credit growth: - Capital risk weights were raised between 2005 and 2008 to counter rapid credit growth in five sectors: capital markets, housing, retail, commercial real estate, and non-deposit taking NBFCs. Some risk weights were lowered at the onset of the financial crisis to mitigate the downturn. - Sectoral provisioning requirements were adjusted during the same periods in conjunction with changes in capital risk weights. - A loan to value (LTV) cap was introduced in November 2010 to counter growth in housing loans and house price inflation. - Calibration and interaction with monetary policy: - Sector-specific LTV caps can be tailored by loan size, location, and value of property. - Sectoral capital risk weights and provisioning requirements were adjusted upwards during a period (September 2004 – August 2008) when the policy interest rate was raised to curb inflation and aggregate demand. - Specific measures in the five sectors reinforced general monetary tightening. - Sectoral risk weights and provisioning requirements were adjusted downwards during October 2008 – April 2009, when monetary policy was eased to mitigate the economic downturn. - Outcomes and circumvention: - The combination of monetary policy and macroprudential instruments had a strong effect on the credit cycle; credit growth in the five affected sectors began to decelerate, notably in commercial real estate. - Anecdotal evidence indicates higher borrowing costs prompted developers and NBFCs to turn to the corporate bond market and to borrow abroad, partially circumventing macroprudential measures. - The effect of macroprudential instruments is not easily distinguishable from general monetary tightening. ### Consolidated supervision of financial conglomerates - Progress and remaining impediments: - Steps taken to improve consolidated supervision of banking groups and a supervisory program initiated to identify and monitor financial conglomerates. - Impediments include lead supervisors being unable to order inspections of subsidiaries they do not regulate or carry out transaction testing at such subsidiaries. - Joint inspections are not conducted, nor can lead supervisors obtain copies of inspection reports directly from other regulators. - Legal and structural recommendations: - RBI has proposed a legal amendment which, if enacted, would address these issues. - It would be beneficial to designate a single supervisor, such as the RBI, to oversee all financial conglomerates regardless of the composition of subsidiaries (banks, securities firms, or insurance companies), while sector regulators continue supervising the underlying entities. - Proposed plans to establish a holding company structure that would own subsidiaries of financial conglomerates would facilitate such oversight arrangements. ### Managing risks: the crisis toolkit — Systemic liquidity management - RBI’s liquidity management framework: - RBI revised the operational framework for monetary policy in early 2011 responding to a movement of the Indian banking system from a position of structural surplus reserve balances to a deficit during the 2008/09 crisis. - The aim is to keep the market in structural deficit and guide short-term interest rates to the policy target via regular open market operations. - The enhanced approach, based on an ample stock of government securities usable as collateral, should ease responses to future liquidity pressures. - Role of CRR and SLR: - CRR and SLR provide liquidity protection during crises but impose costs: raise intermediation costs, encourage disintermediation, and stunt financial market development. - High SLR, held-to-maturity government securities portfolios, and restrictions on market repo hinder yield curve development, weaken monetary policy transmission, and expose banks to unmanaged interest rate risk. - Recommendation: RBI should signal intentions to continue to lower the SLR and bring it into line with emerging prudential liquidity requirements, along with early easing of some restrictions on repo, to foster capital market development. - Lender-of-last-resort discretion: - RBI has wide discretion to lend to individual banks, primary dealers, and other economic agents in support of policy goals, though it was not needed during the 2008/09 crisis. - As SLR is reduced, define details of the lending mechanism: counterparty eligibility, solvency benchmarks, tenor, interest rates, collateral acceptance, and disclosure policies. - SEBI has tightened mutual fund regulation such that liquidity pressures are less likely. - Authorities should review backup liquidity plans for financial market intermediaries, notably central counterparties. ### Crisis management and resolution - Resolution powers and gaps: - The law provides RBI a reasonable range of resolution powers for private commercial banks, but improvements are possible. - Current framework enables RBI to charge losses to shareholders, reduce liabilities, and conduct partial carve-outs after imposing a moratorium on the troubled bank. - Use of a broader toolkit (including purchase & assumption and bridge bank transactions) would require a more explicit mandate for RBI to conduct partial carve-outs. - Moratoria should be optional rather than mandatory to avoid discontinuity in service provision and destruction of franchise value. - The legal framework for public banks is less specific and primarily addresses resolution from the perspective of public banks as acquirers of troubled banks. - Practical use of powers: - In practice, resolution powers for private commercial banks are only partially used: troubled banks were transferred to acquirers in their entirety, including accumulated losses, with acquiring institutions granted a multiyear grace period over which they can write off losses. - Shareholders are thus not necessarily put in a first-loss position, while liability holders’ claims, including depositors, are unaffected. - Handling failure of a large and complex financial institution would likely require the wider set of resolution powers, as the pool of potential acquirers shrinks with bank size. - Transition toward holding company structures should be accompanied by adoption of resolution planning and policies at the group level, complementing frameworks for individual entities. - Urban cooperative banks: - Failures occur regularly in urban cooperative banks, often leading to liquidation. - Since 2005, a total of 230 urban cooperative banks have been either merged with a stronger institution (95) or liquidated (135). - RBI has stepped up efforts to improve the sector and promote consolidation, though significant challenges remain. - Contrary to commercial banks, liability holders in urban cooperative banks do incur losses, while depositors are compensated up to the insured amount. *Source: _cr1308 - 36. Further steps to enhance the specialized expertise of supervisory personnel and* ### 56. The Deposit Insurance and Credit Guarantee Corporation (DICGC) was ### _cr1308 - 56. The Deposit Insurance and Credit Guarantee Corporation (DICGC) was ### Deposit insurance operations, delays, and recommendations - The Deposit Insurance and Credit Guarantee Corporation (DICGC) was established in 1962 as a wholly owned subsidiary of RBI. As a pay-box, it has no role in bank supervision but it does have a funding role in bank resolution. - Delays in depositor payout undermine the effectiveness of deposit insurance in preventing depositor runs; compensation on average takes close to a year. - Identified causes of delays and proposed remedies: - Delays in appointing liquidators can be significant and hamper both depositor payout and asset recovery. - Proposal: provide the DICGC with a greater role in the appointment of liquidators. - Proposal: combine a greater role with a proposed new claim management system to accelerate the process. - Recommendation: DICGC should have an up-to-date “single depositor view” of insured deposits in banks. - The practice of set off contributes to delays and creates uncertainty on the level of protection. - Recommendation: elimination of set off to allow faster determination of individual depositor compensation levels. ### Funding of the DICGC and backup arrangements - Key statistics and facts: - Insured deposits represent 35 percent of total deposits by value. - The deposit insurance fund is funded primarily by premiums paid by covered institutions. - The reserve ratio was 1.4 percent of insured deposits as of end March 2012. - The Act provides for emergency back-up funding from RBI up to INR 50 million. - Recommendations: - Strengthen funding mechanisms of the DICGC. - DICGC should have access to supplementary back-up funding from RBI or, preferably, the government that is rapidly disbursing. - The existing emergency back-up funding limit of INR 50 million appears inadequate in the present context. ### Capital markets development — measures taken and further steps - Recent steps to promote corporate bond market development include: - Simplifying listing and disclosure norms for public and private placement of bonds. - Improving secondary market trade reporting and dissemination. - Improving clearing and settlement. - Eliminating tax deduction at source for listed corporate bonds for Indian residents. - Introducing uniform day count convention for listed bonds. - Introducing RBI guidelines for bilateral corporate bond repos. - Promoting greater foreign participation through enhanced limits for corporate bond investment and reduction of withholding tax for infrastructure fund investments. - Further desirable measures: - Further development of derivatives markets to help investors manage risks; monitor volume, pricing, and use to avoid problems. - Exchange traded derivative products introduced since 2008 include currency futures and options, and interest rate futures (the latter are not liquid). - Guidelines for credit default swaps were issued by RBI in May 2011 and became effective in October 2011. - Relaxation of investment regulations and policies of pension funds and insurers to increase demand (see Section II.B). - Proposed investment guidelines for EPFO would permit limited investment in private sector corporate bonds and equities. - IRDA guidelines permit limited corporate bond investments, essentially only AA or AAA bonds. - Continued gradual liberalization of limits on bond market investment by FIIs to increase demand; FIIs hold 5 percent of corporate bond holdings. - The 2011 budget raised the FII corporate bond limit to US$40 billion, of which US$25 billion is available solely for investment in infrastructure bonds. - The increased allocation contains further restrictions, including a 1-year lock-in period. - The government reduced the withholding tax to 5 percent for infrastructure-related investments. - A less restrictive regime is needed to encourage foreign participation in the bond market more generally. - Improvements to the insolvency regime to strengthen issuer accountability and investor protection; SEBI steps to protect bond investor rights through improved regulation of debenture trustees have been insufficient given low fees and an ‘issuer pays’ model. ### Infrastructure financing — progress, challenges, and policy options - Progress and targets: - Infrastructure finance nearly doubled in the last decade. - The government’s 12th Plan (2012/17) calls for investments in the sector of about US$1 trillion, with a contribution from the private sector of at least half. - Challenges: - Deteriorating global and domestic economic conditions, high inflation, and rising domestic interest rates could raise project financing costs. - Commercial banks have provided the lion’s share of private infrastructure financing to date but cannot continue to do so prudently. - Shallow domestic corporate bond markets and restrictions on institutional investor investments limit alternative local currency financing options. - Indian sponsors are restricted in tapping international debt markets due to restrictions on external commercial borrowing and nonfinancial project risks (contract enforceability, political interference in tariff-setting, delays in approvals). - Short-term mitigation: - Share risk between private and public sector sponsors and design appropriate credit enhancement mechanisms. - Changes needed in bank project appraisal and financing: - Banks should ensure project sponsors hedge currency and interest rate exposures as much as possible (not currently standard). - To reduce risk concentrations and asset-liability mismatches, adopt an ‘originate-carry-refinance’ model: - Charge higher fees and spreads during construction. - Arrange or pre-arrange refinancing with long-term institutional investors or capital markets once projects are commissioned. - RBI could encourage this by accelerating reduction in single borrower limits for infrastructure. - Government initiatives and limitations: - India Infrastructure Finance Company (IIFCL), established in 2010, provides senior and subordinated loans, long-term take-out financing, and credit enhancement, but to date has acted as a conventional senior lender. - IIFCL’s take-out finance facility exists but banks have had little appetite to use it, partly due to banks’ undifferentiated pricing over project life. - Framework for Infrastructure Debt Funds (IDFs) has been developed: - RBI guidelines allow IDFs as NBFCs; SEBI guidelines allow IDFs as mutual funds. - If banks are unwilling to sell post-construction assets, IDFs may lack sufficient supply of assets to purchase. ### Strengthening financial infrastructure — clearing, settlement, and insolvency - Securities and derivatives clearing and settlement systems: - The National Payments System has undergone major reform; systems are comprehensive with prudent risk management frameworks and high operational reliability. - RTGS implemented in 2004 effectively settles large value transactions including the cash leg of government securities transactions. - A detailed assessment of commodity derivatives clearing and settlement systems is desirable given volumes and market growth. - Legal and operational improvements suggested: - Expand legislation to cover finality and netting for stock exchange transactions. - Strengthen liquidity risk management by CCPs. - Establish and regularly test detailed crisis management and default procedures. - Consider replacing the commercial bank settlement model with the central bank settlement model in the medium term. - Recommendation: formalize cooperation between securities and derivatives market regulators and overseers to ensure safety and efficiency of market infrastructure. - Cooperation between RBI and SEBI on payment and settlement systems would benefit from formal arrangements for information sharing and policy coordination. - Inter-regulatory discussions on payment and settlement issues are expected to take place in the FSDC technical committee. - Insolvency regime shortcomings and recommendations: - The general insolvency framework affords inadequate protection to creditors and does not offer a viable rehabilitation regime for distressed companies. - Corporate insolvency is administered by the courts and is plagued with procedural delays that erode company value. - Out-of-court mechanisms exist but present shortcomings; principal tools are Debt Recovery Tribunals (DRTs) and SARFAESI (Securitization and Reconstruction of Financial Assets and Enforcement of Security Interests Act, 2002). - DRTs: - Subject to significant delays—up to four years. - Operate procedurally like inefficient courts, resulting in unpredictable and nontransparent processes. - SARFAESI: - Has significantly improved creditor protections for secured bank lenders but is limited to banks and Housing Finance Companies registered with NHB. - Restrictions on how quickly debt can be enforced cause delays; debtors’ businesses are often broken up and sold rather than sold as a going concern. - Registration of security interests: - The Central Registry under SARFAESI does not operate as an effective, efficient notice of security interest. - Multiple disparate registries exist (Registrar of Companies, Patents Registry, Trademarks Registry, Motor Vehicle Registry, Industrial Design Registry). - Central Registry does not replace other registries, and registration there is not dispositive; creditors must search several registries to ensure rights. - Sole proprietorships and small businesses: - Laws governing insolvency for corporate, nonregistered businesses fail to allow sole proprietors to make a proposal to creditors and are punitive rather than rehabilitative. - Recommendation: enact a unified insolvency law that addresses unincorporated businesses or, at minimum, a more comprehensive “personal” insolvency law for small businesses. ### Market integrity, AML/CFT, and recommendations - Developments and concerns: - Since mid-2009, India has increased focus on money laundering and anti-money laundering provisions. - Some important legal issues remain unresolved, such as the threshold condition for domestic predicate offences. - Effectiveness concerns include the absence of any money laundering convictions. - India shows serious commitment to combating terrorism financing, with active financial investigations and prosecutorial focus, but convictions and firm case law are lacking. - Preventive measures have been expanded and now apply to all but one of the financial activities required under FATF standards; however, several preventive provisions need closer alignment with FATF standards and more time is needed for full implementation. - The supervisory regime for financial institutions is generally sound but its effectiveness for AML/CFT has not been sufficiently demonstrated; sanctions applied for AML/CFT deficiencies have not been effective, dissuasive, or proportionate. - Key recommendations: - Address technical shortcomings in the criminalization of money laundering and terrorist financing and in the domestic framework of confiscation and provisional measures. - Broaden customer due diligence obligations with clear, specific measures to enhance requirements regarding beneficial ownership. - Improve reliability of identification documents, use of pooled accounts, treatment of politically exposed persons, and handling of non-face-to-face business. - Ensure India Post effectively implements AML/CFT requirements now that it is subject to the Prevention of Money Laundering Act. - Enhance effectiveness of the suspicious transactions reporting regime. - Enhance effectiveness of the financial sector supervisory regime and ensure India Post is adequately supervised. - Ensure competent supervisory authorities change sanctioning regimes to allow effective, proportionate and dissuasive sanctions for AML/CFT failures. - Extend the Prevention of Money Laundering Act to the full range of designated nonfinancial businesses and professions and ensure they are effectively regulated and supervised. ### Risk assessment matrix — selected threats (summary) - Continued high or accelerating inflation: - Staff assessment: MEDIUM. - Expected impact: Staff assessment: MEDIUM to HIGH — could limit RBI’s room to lower policy rates; growth would likely remain above 6 percent; higher interest rates would exacerbate maturity mismatches from long-term infrastructure investments. - Slowdown in economic growth fueled by domestic or external shocks: - Staff assessment: MEDIUM. - Expected impact: Staff assessment: MEDIUM to HIGH — slower GDP growth would reduce credit demand and net interest margins; weaken corporate and small business profits and employment; undermine credit quality. - Sharp reversal of capital flows: - Staff assessment: MEDIUM. - Expected impact: Staff assessment: MEDIUM to HIGH — could become more pronounced as exposure to foreign markets grows; heightened volatility could pressure systemic liquidity and affect banks and other intermediaries; impact on exchange rates could be significant though banks’ FX exposure remains limited. - Decline in real estate prices: - Staff assessment: MEDIUM. - Expected impact: Staff assessment: MEDIUM — a fall in real estate prices or increased property-related credit risk would undermine asset quality; additional risks from home loans with ascending interest rate/teaser rates. *Source: IMF staff report content provided in the supplied PDF excerpt.* ### Appendix Table 2. India: Selected Economic Indicators, 2007/08–2012/13 ### Appendix Table 2. India: Selected Economic Indicators, 2007/08–2012/13 ### GDP and Social Indicators - Nominal GDP (billions of U.S. dollars): 1,684 - GDP per capita (U.S. dollars): 1,420 - Population (2010): Total (in billions): 1.21 - Urban population (percent of total): 31 - Life expectancy at birth (years): 65 - Poverty: Headcount ratio (2005): 37.2 - Undernourished (2000): 19.0 - Income distribution (2005, WDI): - Richest 10 percent of households: 31.1 - Poorest 20 percent of households: 8.1 - Gini index: 36.8 ### Growth (y/y percent change) - Real GDP (at factor cost) by fiscal year: - 2007/08: 9.3 - 2008/09: 6.7 - 2009/10: 8.4 - 2010/11: 8.4 - 2011/12: 6.8 - 2012/13 Prel./Est./Proj.: 7.0 - Real GDP (calendar year basis): - 2007: 9.4 - 2008: 7.3 - 2009: 8.0 - 2010: 8.4 - 2011: 6.8 - 2012 Proj.: 7.1 - Industrial production: - 2007/08: 15.5 - 2008/09: 2.5 - 2009/10: 5.3 - 2010/11: 8.2 ### Prices (y/y percent change, average and end-period) - Wholesale prices (2004/05 weights), average: - 2007/08: 4.7 - 2008/09: 8.1 - 2009/10: 3.8 - 2010/11: 9.6 - 2011/12: 8.7 - 2012/13: 7.2 - Wholesale prices (2004/05 weights), end of period: - 2007/08: 7.7 - 2008/09: 1.6 - 2009/10: 10.4 - 2010/11: 9.7 - 2011/12: 6.8 - 2012/13: 7.0 - Consumer prices - industrial workers (2001 weights): - 2007/08: 6.2 - 2008/09: 9.1 - 2009/10: 12.4 - 2010/11: 10.4 - 2011/12: 8.1 - 2012/13: 8.5 ### Saving and Investment (percent of GDP) - Gross saving 2/: - 2007/08: 36.4 - 2008/09: 31.7 - 2009/10: 33.5 - 2010/11: 31.3 - 2011/12: 31.3 - 2012/13: 30.4 - Gross investment 2/: - 2007/08: 37.7 - 2008/09: 34.0 - 2009/10: 36.3 - 2010/11: 34.0 - 2011/12: 34.0 - 2012/13: 33.4 ### Fiscal Position (percent of GDP) - Central government deficit: - 2007/08: -3.1 - 2008/09: -6.8 - 2009/10: -6.5 - 2010/11: -6.1 - 2011/12: -5.9 - 2012/13: -5.8 - General government deficit: - 2007/08: -4.4 - 2008/09: -9.0 - 2009/10: -9.9 - 2010/11: -8.8 - 2011/12: -8.1 - 2012/13: -7.7 - General government debt 4/: - 2007/08: 74.6 - 2008/09: 75.4 - 2009/10: 71.3 - 2010/11: 66.7 - 2011/12: 66.2 - 2012/13: 65.7 ### Money and Credit (y/y percent change, end-period) 5/ - Broad money: - 2007/08: 21.4 - 2008/09: 19.3 - 2009/10: 16.8 - 2010/11: 16.0 - 2011/12: 31.1 - 2012/13: 18.2 - Credit to commercial sector: - 2007/08: 21.1 - 2008/09: 16.9 - 2009/10: 15.8 - 2010/11: 21.3 - 2011/12: 18.8 ### Financial Indicators (percent, end-period) 6/ - 91-day treasury bill yield: - 2007/08: 7.2 - 2008/09: 5.0 - 2009/10: 4.4 - 2010/11: 7.3 - 10-year government bond yield: - 2007/08: 7.6 - 2008/09: 7.0 - 2009/10: 7.8 - 2010/11: 8.0 - Stock market (y/y percent change, end-period): - 2007/08: 19.7 - 2008/09: -37.9 - 2009/10: 80.5 - 2010/11: 10.9 ### External Trade and Balance of Payments (US$ billions) - Merchandise exports: - 2007/08: 166.2 - 2008/09: 189.0 - 2009/10: 182.4 - 2010/11: 250.5 - 2011/12: 274.2 - 2012/13: 307.4 - Merchandise exports y/y percent change: - 2007/08: 28.9 - 2008/09: 13.7 - 2009/10: -3.5 - 2010/11: 37.3 - 2011/12: 9.5 - 2012/13: 12.1 - Merchandise imports: - 2007/08: 257.6 - 2008/09: 308.5 - 2009/10: 300.6 - 2010/11: 381.1 - 2011/12: 428.2 - 2012/13: 489.1 - Merchandise imports y/y percent change: - 2007/08: 35.1 - 2008/09: 19.8 - 2009/10: -2.6 - 2010/11: 26.7 - 2011/12: 12.4 - 2012/13: 14.2 - Current account balance (US$ billions): - 2007/08: -15.7 - 2008/09: -27.9 - 2009/10: -38.2 - 2010/11: -45.9 - 2011/12: -47.6 - 2012/13: -56.3 - Current account balance (in percent of GDP): - 2007/08: -1.3 - 2008/09: -2.3 - 2009/10: -2.8 - 2010/11: -2.7 - 2011/12: -2.8 - 2012/13: -3.0 - Foreign direct investment, net: - 2007/08: 15.9 - 2008/09: 22.4 - 2009/10: 18.0 - 2010/11: 9.4 - 2011/12: 18.8 - 2012/13: 22.3 - Portfolio investment, net (equity and debt): - 2007/08: 27.4 - 2008/09: -14.0 - 2009/10: 32.4 - 2010/11: 30.3 - 2011/12: 11.1 - 2012/13: 24.1 - Overall balance: - 2007/08: 92.1 - 2008/09: -20.6 - 2009/10: 13.0 - 2010/11: 12.9 - 2011/12: 5.5 - 2012/13: 17.1 ### External Indicators - Gross reserves (in billions of U.S. dollars, end-period): - 2007/08: 309.7 - 2008/09: 252.0 - 2009/10: 279.1 - 2010/11: 293.1 - 2011/12: 298.6 - 2012/13: 315.7 - Gross reserves (In months of imports) 8/ 9/: - 2007/08: 10.3 - 2008/09: 8.4 - 2009/10: 7.2 - 2010/11: 6.8 - 2011/12: 5.7 - 2012/13: 5.5 - External debt (in billions of U.S. dollars, end-period) 8/: - 2007/08: 224.4 - 2008/09: 224.5 - 2009/10: 261.0 - 2010/11: 298.4 - 2011/12: 337.4 - 2012/13: 384.7 - External debt (percent of GDP, end-period): - 2007/08: 18.1 - 2008/09: 18.4 - 2009/10: 19.2 - 2010/11: 17.7 - 2011/12: 19.7 - 2012/13: 20.7 - Short-term debt (of which), percent: - 2007/08: 6.8 - 2008/09: 6.7 - 2009/10: 6.7 - 2010/11: 6.9 - 2011/12: 8.0 - 2012/13: 8.7 - Ratio of gross reserves to short-term debt (end-period): - 2007/08: 3.7 - 2008/09: 3.1 - 2009/10: 3.1 - 2010/11: 2.5 - 2011/12: 2.2 - 2012/13: 2.0 - Debt service ratio 10/ (percent): - 2007/08: 5.3 - 2008/09: 5.1 - 2009/10: 4.9 - 2010/11: 4.7 - 2011/12: 5.6 - 2012/13: 5.8 - Real effective exchange rate (y/y percent change, period average): - 2007/08: 8.7 - 2008/09: -6.8 - 2009/10: 8.0 - 2010/11: 11.6 - Exchange rate (rupee/US$, end-period) 6/: - 2007/08: 40.35 - 2008/09: 51.24 - 2009/10: 45.54 - 2010/11: 45.0 Notes (selected): - 1/ Data are for April-March fiscal years. - 2/ Differs from official data, calculated with gross investment and current account. Gross investment includes errors and omissions. - 3/ Divestment and license auction proceeds treated as below-the-line financing. Subsidy related bond issuance classified as expenditure. - 4/ Includes combined domestic liabilities of the center and the states, inclusive of MSS bonds, and external debt at year-end exchange rates. - 5/ For 2011/12, as of October 2011. - 6/ For 2011/12, as of October 2011. - 7/ On balance of payments basis. - 8/ Imports of goods and services projected over the following twelve months. - 9/ Short-term debt on residual maturity basis, including estimated short-term NRI deposits on residual maturity basis. - 10/ In percent of current account receipts excluding grants. *Sources: Data provided by the Indian authorities; CEIC Data Company Ltd; Bloomberg L.P.; World Development Indicators; and IMF staff estimates and projections.* ### Financial System Structure (2010) - Scheduled Commercial Banks: No. of Institutions: 81; Total Assets (in INR billion): 60,251; Percent of Total Assets: 58.4; Percent of GDP: 77.5 - Public Sector Banks: 27; 44,411; 43.1; 57.1 - Private Sector Banks—Old: 15; 2,690; 2.6; 3.5 - Private Sector Banks—New: 7; 8,818; 8.6; 11.3 - Foreign Banks: 32; 4,332; 4.2; 5.6 - Regional Rural Banks: 82; 1,507; 1.5; 1.9 - Local Area Banks: 6; 946; 0.9; 1.2 - Cooperative Credit Institutions: 98,425; 6,829; 6.6; 8.8 - Urban Cooperative Banks: 1,674; 2,361; 2.3; 3.0 - Rural Cooperative Credit Institutions: 96,751; 4,468; 4.3; 5.7 - Non-banking Financial Institutions (NBFIs): 603; 9,300; 9.0; 12.0 - Non-banking Financial Companies (NBFCs): 578; 6,728; 6.5; 8.7 - Deposit-taking NBFCs: 311; 1,093; 1.1; 1.4 - Non-Deposit-taking NBFCs: 267; 5,635; 5.5; 7.2 - Financial Institutions 1/: 5; 2,469; 2.4; 3.2 - Primary Dealers: 20; 103; 0.1; 0.1 - Insurance Companies 2/ 3/: 47; 13,920; 13.5; 17.9 - Non-Life Insurance: 24; 664; 0.6; 0.9 - Life Insurance: 23; 13,256; 12.9; 17.0 - Provident and Pension Fund: 4,243; Percent of Total Assets: 4.1; Percent of GDP: 5.5 - Mutual Funds 2/ 4/: 882; 6,140; 6.0; 7.9 Notes: - 1/ comprise specialized and development institutions. - 2/ Assets under management (AUM). - 3/ Includes general annuity funds. - 4/ Number of funds. *Sources: RBI, IRDA, SEBI, WEO, IMF Staff Computations.* ### Financial Soundness Indicators (selected, 2006–2010) - Risk-weighted capital adequacy ratio (CAR) 1: - 2006: 12.30 - 2007: 12.30 - 2008: 13.00 - 2009: 13.20 - 2010: 13.60 - Public sector banks (2006–2010): 12.20; 12.40; 12.50; 12.30; 12.10 - Old Private Sector Banks (2006–2010): 11.70; 12.10; 14.10; 14.30; 13.80 - New Private Sector Banks (2006–2010): 12.60; 12.00; 14.40; 15.10; 17.30 - Foreign banks (2006–2010): 13.00; 12.40; 13.10; 15.00; 18.10 - Net nonperforming loans (percent of outstanding net loans) 2: - All banks (2006–2010): 1.20; 1.00; 1.10; 1.10; 1.10 - Public sector banks: 1.30; 1.10; 1.10; 0.90; 1.10 - Old Private Sector Banks: 1.70; 1.00; 0.70; 0.90; 0.80 - New Private Sector Banks: 0.80; 1.00; 1.40; 1.40; 1.10 - Foreign banks: 0.80; 0.70; 0.80; 1.80; 1.80 - Gross nonperforming loans (percent of outstanding loans): - All banks (2006–2010): 3.30; 2.50; 2.40; 2.30; 2.40 - Public sector banks: 3.60; 2.70; 2.30; 2.00; 2.20 - Old Private Sector Banks: 4.40; 3.10; 2.30; 2.40; 2.30 - New Private Sector Banks: 1.70; 1.90; 2.90; 3.10; 2.90 - Foreign banks: 1.90; 1.80; 1.90; 3.80; 4.30 - Net profit (+)/loss (-) of commercial banks (percent of assets) 3: - All banks (2006–2010): 0.90; 0.90; 1.00; 1.00; 0.90 - Public sector banks: 0.80; 0.80; 0.90; 0.90; 0.90 - Old Private Sector Banks: 0.60; 0.70; 1.00; 1.00; 0.90 - New Private Sector Banks: 1.00; 0.90; 1.00; 1.10; 1.20 - Foreign banks: 1.50; 1.70; 1.80; 1.70; 1.10 - Net interest margin (ratio of net interest income to total assets): - 2006: 3.04 - 2007: 2.99 - 2008: 2.58 - 2009: 2.62 - 2010: 2.55 - Interest income to total assets: - 2006: 7.21 - 2007: 7.59 - 2008: 7.92 - 2009: 8.12 - 2010: 7.38 - Non-interest income to total assets: - 2006: 1.38 - 2007: 1.25 - 2008: 1.55 - 2009: 1.57 - 2010: 1.39 - Balance sheet structure of all scheduled banks: - Loan/deposit ratio (2006–2010): 70.10; 73.50; 74.60; 73.90; 73.60 - Investment in government securities/deposit ratio: 31.90; 28.00; 27.90; 28.70; 28.80 - Lending to Priority Sector (percent of total lending): 33.81; 33.08; 31.55; 30.30; 31.21 - Lending to sensitive sectors (percent of loans and advances), selected sectors: - Real estate (2006–2010): 17.20; 18.80; 18.40; 17.50; 16.60 - Commodities (2006–2010): 0.09; 0.11; 0.10; 0.00; 0.00 Selected nonbank and cooperative indicators: - Regional Rural Banks (RRBs): - Gross nonperforming loans (percent): 8.57; 7.30; 6.60; 3.66; 4.14 - Total capital-to-total assets (percent): 4.98; 4.82; 4.76; 4.61; 4.49 - Net profit (+)/loss (-): 1.04; 0.59; 1.11; 1.00; 1.10 - Loss Making RRBs-to-All RRBs (percent): 16.54; 15.63; 8.89; 6.98; 3.66 - Urban Cooperative Banks (UCBs): - Gross nonperforming loans (percent): 18.90; 18.30; 16.40; 13.37; 11.54 - Total capital-to-total assets (percent): 2.31; 2.46; 2.60; 2.56; 2.39 - Net profit (+)/loss (-): 0.34; 0.01; 0.01; 0.80; 0.70 - Rural Cooperative Banks (RCBs): - Gross nonperforming loans (percent): 23.80; 19.80; 25.90; 29.70; N.A. - Total capital-to-total assets (percent): 14.76; 14.65; 13.90; 13.95; N.A. - Net profit (+)/loss (-): 2.70; 0.00; -1.03; 0.09; N.A. - Non-banking Financial Companies—Deposit Taking (NBFC-D): - Gross nonperforming loans (percent): 3.60; 2.20; 2.10; 2.00; 1.30 - Total capital-to-total assets (percent): 19.70; 16.74; 16.89; 17.15; 16.65 - Net profit (+)/loss (-): 1.50; 1.04; 2.86; 2.69; 1.50 - Non-banking Financial Companies—Non Deposit Taking, Systemically Important (NBFC-ND-SI): - Gross nonperforming loans (percent): 4.30; 2.30; 2.30; 2.90; 3.00 - Total capital-to-total assets (percent): 23.24; 23.02; 26.94; 27.08; 25.83 - Net profit (+)/loss (-): 1.72; 2.35; 2.13; 2.20; 1.90 *Source: Annual Report, and Trends and Progress of Banking in India.* ### Infrastructure of Securities Markets (selected) - Main securities and derivatives settlement systems and roles: - CCIL: CCP for government securities, money market, and foreign exchange instruments. - Public Debt Office (PDO) of RBI: Central Securities Depository (CSD) for government securities. - NSCCL, BSE, ICCL: CCPs for equity and equity derivatives traded on NSE and BSE. - NSCCL, MCX-SX CCL, ICCL: CCPs for currency derivatives traded on NSE, MCX-SX and USE. - NSDL and CDSL: CSDs for corporate securities traded on NSE and BSE respectively. - Cash and securities settlement links noted including DvP 3 arrangements and links between NSDL/CDSL and RBI RTGS for cash settlement of government bonds, and links for cash settlement of corporate bonds. *Source: National authorities.* ### Summary Assessments: Basel Core Principles for Effective Banking Supervision (selected findings) - Assessment context: - Conducted as part of the joint IMF-World Bank FSAP; assessment conducted from June 15 till July 1, 2011; reflects RBI practices as of end-May 2011 and covers only commercial banks. - Assessment based on RBI self-assessments (2011 and 2009), interviews, legal and supervisory documentation, onsite/offsite reports, and meetings with MoF, banks, auditors, and industry associations. - Key strengths and recent initiatives: - Tightly controlled regulatory and supervisory regime: higher than minimum capital requirements; frequent, hands-on onsite inspections; conservative liquidity risk policy; restrictions on volatile exposures. - Banking system largely stable during the global financial crisis. - Government and RBI actions to enhance soundness and resilience, including establishment of FSDC, implementation of countercyclical provisioning regime, and roadmap for introduction of a holding company structure. - Gaps and ongoing work: - Remaining gaps and constraints in implementation of regulatory and supervisory framework. - RBI actions underway: proposed changes in banking law; more MOUs for home/host coordination; initial steps toward more risk-based supervision; initiative to consider supervisory process modifications for largest banking groups. - Preconditions and structural issues: - RBI has legal oversight of payment and settlement systems via the Payment and Settlement Systems Act, 2007 and Regulations; Act defines settlement finality and multilateral netting. - Insolvency framework: significant weaknesses remain; multiplicity of laws and difficult process for registering security interests; Debt Recovery Tribunals (DRTs) and SARFAESI present limitations with low recovery returns and long liquidation periods. - Accounting and auditing: convergence with IFRS planned for 2013; ICAI sets standards with RBI-specific carve-outs on provisioning and disclosure; Quality Review Board and disciplinary functions need activation and strengthened independence for Auditing and Assurance Standards Board. *This Annex contains summary assessments of India’s observance of financial sector standards and codes; assessments based on detailed reviews of Basel Core Principles, IAIS ICP, IOSCO principles, and CPSS-IOSCO recommendations.* *Sources: IMF staff assessments; National authorities; World Bank inputs.* ### 82. The legislative framework for AML/CFT has been set out in the Prevention of ### _cr1308 - 82. The legislative framework for AML/CFT has been set out in the Prevention of ### AML/CFT legislative and supervisory framework (paragraph 82) - The legislative framework for AML/CFT has been set out in the Prevention of Money Laundering Act, 2002. - Respective regulators have issued guidelines for entities regulated by them. - Initiatives by various financial sector regulators include: - Issuance of guidelines for submission of currency transaction reports and suspicious transaction reports to the Financial Intelligence Unit and preservation of records. - Guidelines on wire transfers to banks. - Major areas needing action to further strengthen AML/CFT practices and align with international standards: - Effective implementation of record-keeping requirements. - A robust regime for submission of suspicious transaction reports. ### Disclosure, accounting, and market transparency (paragraphs 83, 97) - Listed companies: - Subject to a modern continuous disclosure regime. - Banks: - Subject to specific disclosure requirements including publication of their annual reports. - RBI prescribes key elements to be disclosed, including governance and risk management arrangements, as well as audited financial statements. - RBI publishes financial statement information on the industry. - Identified needs: - Strengthen the disclosure mechanism to bring greater transparency in ownership structures. - Stringent penal action where nontransparent practices are unearthed. - Implementation of IFRS in India is generally expected to further reinforce effective market discipline. - Interaction with external auditors: - Room for improvement in the frequency and intensity of interaction between RBI and external auditors and access rights to the external auditor’s working papers. - RBI does not have direct authority to rescind the appointment of the external auditor but can and has withdrawn approval of the appointment. ### Lender of last resort powers and deposit insurance (paragraphs 84–85) - RBI’s powers: - RBI has broad and strong lender of last resort powers, under review in light of lessons from the global financial crisis. - Under section 17 and 18 of the RBI Act (‘war-time’ powers) RBI has wide discretion to lend to economic agents in support of its policy goals. - Existing instruments are considered adequate; RBI does not encourage providing ex ante assurance about its emergency support. - Deposit insurance: - A deposit insurance system is in place. - The DICGC, a wholly owned subsidiary of RBI, covers all commercial banks, including local area banks and regional rural banks in all the states and union territories. ### Domestic crisis management and institutional arrangements (paragraph 86) - Governance arrangements are being strengthened. - Establishment in December 2010 of the FSDC and its subcommittee to coordinate among regulators and the government. - Roles: - Subcommittee expected to evolve as a more active, hands-on body for financial stability in normal times. - FSDC to have broad oversight and assume a central role in crisis times. - Gap identified: - Contingency plans and action plans are not yet established. ### Main findings: objectives, independence, powers, transparency and cooperation (CP 1) (paragraphs 87–90, 96, 99) - Independence and legal framework: - The independence of RBI is not enshrined in the law and some legal provisions could undermine independence from the government. - Legal provisions in the Banking Regulation Law and the RBI Act allow the central government to give directions to RBI, require it to perform inspections, overrule decisions, and supersede the Board of RBI; these provisions have never been used. - Recommendation: It would be beneficial to remove such provisions from the law to provide greater legal certainty. - RBI does not have the power to disempower a public bank from carrying on banking activities. - Reasons for removal of the RBI governor are not specified in the law; governor is appointed for a maximum term with possibility of reappointment (not a minimum term). - Nominee director in public banks: - In public banks, an RBI representative still acts as a director on the Board; this person is a current RBI employee from a department other than banking supervision. - This provision has potential to blur distinction between RBI’s supervisory powers and bank management; greater clarity should be provided to banks on the limitations of the role. - Legal protection for supervisors: - Legal protection for bank supervisors is in place; employees’ costs of defending actions made while discharging duties in good faith are borne by RBI. - Suggested enhancements: - Act should state that legal protection is not limited in time (beyond termination of appointment/employment). - Protection against incurring costs of defending supervisors should be stated clearly and explicitly (at least at the level of internal procedures), including financing of expenses since the start of legal proceedings. - Supervisory cooperation and information sharing: - RBI has entered into MOUs with foreign supervisory authorities and has received approval from the central government for this purpose. - RBI lacks extensive formal or informal supervisory information sharing arrangements. - Given large and growing overseas activities of Indian banks in many foreign jurisdictions, including some unstable and high-risk countries, the absence of arrangements for supervisory information sharing should be addressed as soon as possible. - RBI does not have direct access to call for information for any entity in the banking group; proposed amendment to Section 29A of the Banking Regulation Act under the Banking Law Amendment Bill 2011 is expected to remedy this gap. - Supervisory methods and staffing (paragraph 96): - RBI supervises direct activities of banks with well defined onsite practices, extensive regulatory reporting, and improving offsite monitoring. - More structured interaction between in-house regulatory areas and field inspectors would enhance rigor and consistency. - Challenges exist in maintaining specialized supervisory expertise given RBI-wide staff rotation policies. ### Licensing and structure (CPs 2–5) (paragraph 91) - India has a sound framework for granting banking licenses and overseeing prospective ownership changes and intended bank expansion. - Clear demarcation between banks and nonbanks; well defined set of permissible bank activities. - Improvement opportunities: - Controlling foreign bank entry and Indian bank expansion overseas. - Ensuring strong risk management programs are implemented by new banks. ### Prudential regulation and requirements (CPs 6–18) (paragraphs 92–95) - Capital and Basel II: - RBI has set prudent minimum capital adequacy requirements and defined components of capital in accordance with internationally agreed guidelines. - Challenges remain for migration to Basel II advanced approaches: data, tools, methodologies, required skills for quantification/modeling of risks, and model validation. - RBI will need to address practical implementation issues consistently and enhance supervisory policies and practices for banks applying Basel II advanced models. - Risk model review and consolidated supervision: - Recommendation to establish requirement for periodic and rigorous risk model review and validation by banks, even for models not used for regulatory capital. - Prudential guidance should be applied to the consolidated banking group rather than just the bank. - Concentration limits and connected counterparties: - Prudential framework characterized by concentration limits significantly higher than international best practice and a too general definition of connected counterparties. - Current large exposure limit is a maximum of 55 percent of a banking groups’ capital. - Recommendation: More guidance and more frequent and detailed onsite verification of criteria for determination of “connected exposures”; broaden guiding principles to include cross-guarantees or financial interdependency. - Other prudential enhancements: - Clarify definition of related parties and requirements for arm’s length transactions. - Introduce formal legal or regulatory requirement to inform RBI immediately of any adverse developments in operational risk. - Enhance internal control framework by ensuring updates on developments affecting the fit and proper test for existing directors and stronger focus in annual financial inspection on the quantity and skill of people in risk management and control functions. ### Corrective powers, consolidated and cross-border supervision (paragraphs 98–99) - Corrective and remedial powers: - RBI has broad discretion and a prompt corrective action regime for problem situations; architecture is sound for private banks but not generally applicable in practice to public banks, which make up the largest percentage of the market. - Consolidated and cross-border supervision: - RBI has begun efforts to improve focus on consolidated supervision and cross-border supervision, establishing more structured forums for interaction with domestic functional regulators and executing MOUs with foreign supervisors. - Suggested improvements: - Broaden supervisory focus domestically by changing practices for obtaining information from firms and using a more appropriate construct for evaluating consolidated firms. - Interact more effectively with functional regulators. - Passage of proposed statutory amendment would improve RBI’s consolidated information access. ### Annex summary points (selected from Annex Table 5: India — Summary of Compliance with the Basel Core Principles) - Independence, accountability and transparency (1.2): - The reasons for removal of the head of the supervisory agency during term are not specified in law; assessors confirm specification of reasons in law and requirement to disclose them is required by essential criterion 1. - Legal provisions allow central government powers over RBI; removal of these provisions would provide greater certainty regarding RBI independence. - Role of nominee director in public sector banks blurs distinction between supervisory powers and management; recommendation to abolish role or at least clarify limitations. - Banking Regulation Act should allow RBI to enter into MOUs without central government agreement. - Governor appointment is for a maximum term with possibility of reappointment (not a minimum term). - Recommendation to reconsider strict rotation policies to ensure staff build-up of expertise in banking supervision; consider narrower rotation areas and supervisory rotations for specific supervised entities. - Legal powers and protection (1.4–1.5): - RBI largely has requisite authority to address compliance but lacks authority to disempower a public bank from carrying on banking activity. - Recommendation: State more clearly (preferably in law) protection for costs of defending supervisors’ actions, including financing expenses from the start of legal proceedings. - Cooperation (1.6): - Absence of formal/exensive arrangements for receiving information from host supervisors is a serious problem given banks’ overseas activities; accelerate MOUs or other means. - Creation of FSDC and subcommittee may help improve information exchange if FSDC focuses on: - Regular sharing of written material (including inspection reports) on a timely basis. - Broad and operational escalation protocols (covering IRDA and SEBI) to promptly alert other supervisors. - Semi-annual meetings on major banking companies involving supervised firm and regulators-only discussions. - Proposed change to Section 29A would allow RBI to call for information from any entity in the banking group, improving direct access to subsidiaries and associated companies’ information. - Licensing criteria (CP 3): - RBI has a clear licensing process; areas to strengthen include: - Closer ex ante review of intended risk management and control systems of proposed new banks or early examination within first six to twelve months of operations. - Requiring foreign bank applicants be subject to overall consolidated supervision in home country. - Considering requirement for ongoing information exchange with home country supervisor as condition for licensing an office of a foreign bank. *Source: IMF assessment content provided in the supplied excerpt.* ### 4. Transfer of significant ### 4. Transfer of significant ownership ### Transfer of significant ownership — findings and recommendations - RBI has the legal authority and operating procedures to review changes in the ownership of shares of banking companies. - The definition of substantial interest is focused on beneficial ownership, avoiding issues with shares held by nominees. - Concern: control can be exercised through means other than shareholdings; recommendation to incorporate a more judgmental test of controlling interest. - Concern: possibility of a change in ownership of an existing shareholder that would not be subject to review. ### Major acquisitions — findings and improvements needed - The structured approach for reviewing prospective investments in subsidiaries contains key elements to ensure focus on banking activities and provide RBI oversight on expansion. - Areas to address: - RBI’s capacity to monitor risks of a nonbank subsidiary and to take timely action is limited by: - potential time-lags in getting information concerning entities regulated by other agencies, and - lack of legal authority to request information about unregulated entities. - A more systematic approach to critical review of host country supervisory arrangements should be developed and implemented. ### Capital adequacy — findings and recommendations - RBI has set prudent and appropriate minimum capital adequacy requirements reflecting banks’ risks. - Components of capital are defined in accordance with internationally agreed guidelines. - RBI has legal power to require higher capital ratios for individual banks. - RBI’s requirements are stricter than those established in the applicable Basel requirements. - RBI will move to Basel III on the internationally agreed timeline. - Recommendation: RBI should issue guidelines requiring adequate distribution of capital among different entities of the banking group. - Migration to the Basel II advanced approaches faces challenges related to constraints on data, tools, methodologies, and skills for quantification, modeling, and validation of risks. - RBI needs to consider practical implementation issues consistently and may have to enhance supervisory policies and practices for ongoing supervision of banks applying the Basel II advanced models. ### Risk management process — findings and opportunities - RBI has issued guidance on key elements of risk management structure and operations; annual financial inspection process assesses compliance. - Areas for improvement: - Establish requirement for periodic and rigorous model review and validation by banks, even for internal risk models not used for regulatory capital purposes. - Ensure risk guidance is issued to, and applied to, the consolidated banking company rather than just the bank. ### Credit risk — findings and recommendations - Paragraph 3 of the 1999 Risk Management Guidelines states banks should have a multi-tier credit approving system, but: - No explicit RBI requirement that major credit risk exposures exceeding a certain amount or percentage of capital, or especially risky exposures, be decided by senior management. - No specific regulatory requirement that potential future exposure be included in credit management strategies or policies. - Recommendation: RBI should consider requiring banks to have a comprehensive model validation policy approved by the Board (see also CP 7). - Banks on the standardized approach should also be subject to validation requirements if they use internal models for purposes such as pricing. ### Large exposure limits — findings and concerns - More detailed requirements and guidance on criteria for determining “connected exposures” is required; could broaden guiding principles to include cross-guarantees or financial interdependency. - RBI examiners should verify definitions of connected parties in more depth during annual financial inspection. - The large exposure limit of 40 percent—which can exceptionally be brought to 50 percent for infrastructure exposures—for a group borrower is significantly higher than the 25 percent large exposure limit that is considered good international practice. - Assessors believe the 40 percent/50 percent limit has potential to allow the default of one consolidated borrower to cause serious capital loss in a banking company and is significantly out of line with international good practice. ### Exposure to related parties — findings and actions needed - Elements of the legal and regulatory structure are reasonably conservative (general prohibition on lending to directors; transactions with affiliates on arm’s length basis). - Significant areas to address: - The definition of related parties fails to include shareholders or promoters; this gap should be remedied. - Regulatory approaches should be developed for excluding such lending from capital or for taking other adjustment steps. - A law change is being proposed to require by explicit provision in law that loans to subsidiaries and joint ventures be on an arm’s length basis. A regulatory provision to ensure such arm’s length relationships with some subsidiaries currently is in place. ### Liquidity risk — findings - RBI has put in place a very conservative framework for liquidity risk management. - Annual financial inspection critically reviews duration gap analysis and integrity of data systems supporting liquidity metrics. ### Operational risk — findings and timelines - No legal or regulatory requirement for banks to inform RBI of adverse developments in operational risk; in practice, quarterly meetings ensure RBI is informed of material adverse developments within maximum three months after the facts. - In 2010 RBI set up a Working Group on Information Security, Electronic Banking, Technology Risk Management, and Cyber Frauds; recommendations covered nine broad areas: IT governance, information security, information security audit, IT operations, IT services outsourcing, cyber fraud, business continuity planning, customer awareness programs, and legal aspects. - RBI required banks to conduct formal gap analysis and establish time-bound action plans; implementation deadlines: - Basic organizational framework, policies, and procedures: banks need to ensure implementation by October 31, 2011. - The rest of the guidelines: need to be implemented by April 2012 unless a longer timeframe is indicated in the circular. - Some provisions are recommendatory and left to banks’ discretion. - Requirements were not in place at the assessment date but their implementation is expected to strengthen operational risk management. ### Internal control and audit — findings and improvements - RBI has a good framework for internal controls; annual financial inspections evaluate internal audit governance, sanction authorities, and compliance approach and effectiveness. - Areas for improvement: - Ensure updates on developments affecting the fit and proper test for existing directors are received. - Ensure annual financial inspections focus on assessing the quantity and skill level of people in risk management and control functions. ### Abuse of financial services / AML/CFT — findings - Issues raised in the FATF Mutual Assessment Report on AML/CFT within RBI’s responsibility have been addressed. - RBI’s regulatory framework for AML generally complies with the essential criteria of this Core Principle. - Inspection reports mention many critical weaknesses in AML/Know your Customer; KYC/AML inspections have only started recently and full compliance is not expected at this stage. ### Supervisory approach — staffing, structure, and focus - RBI has extensive onsite inspections and offsite monitoring of financial returns. - Staffing: As of 2011, 645 people work in the Department of Banking Supervision (from 729 two years ago). - Given Basel process demands and movement to more continuous supervision for twelve of the largest banking companies (see CP 20), assessors believe staffing should be reviewed to ensure appropriate quantity and quality of staff (see also CP 1.2). - Recommendation: Reassess general practice of rotating people across RBI departments to develop specialized expertise; consider having the bulk of supervisory/regulatory staff spend the majority of their career in bank supervision/regulation. - Increase focus on consolidated risks of the banking group; consider methodology for rating banking companies to reflect issues arising at nonbank subsidiaries. - Issue clearer guidance on need for banking groups to provide updates on developments and changes between annual financial inspections. - Ensure review and validation of models used for internal risk management, even if not used for regulatory capital purposes, is consistently done. ### Supervisory techniques — principal improvements needed - RBI utilizes onsite supervision and offsite monitoring. - Principal improvements: 1. Provide a regular forum for Regional Office inspectors and Central Office to review findings and develop horizontal perspectives. 2. More intensive reviewing of nonbank subsidiaries. 3. Improved monitoring of foreign operations through better information flow from overseas supervisors and/or more overseas inspections. 4. Ensure critical review and validation of risk management models not yet used for regulatory capital purposes. 5. Develop more structured interaction throughout the year with directors of private sector banking companies. - Initiative: A Steering Group, led by a Deputy Governor, began a year-long review in April 2011 to consider potential supervisory changes. - Departmental changes announced to move offsite monitoring closer to onsite inspection; a new supervisory regime for the largest (12) systemically important banking companies was planned involving: - Supervisory responsibility moved from Regional Offices to the Central Office; and - Shift from once-a-year supervision to more continuous supervision with targeted reviews. ### Supervisory reporting — legal limitation and proposed amendment - RBI does not have the power to require information from affiliated but unregulated entities of a banking group. - A legal amendment has been proposed to address this concern. ### Accounting and disclosure — findings and recommendations - RBI does not have direct authority to rescind appointment of a statutory auditor; authorities have withdrawn approval in the past when serious external auditor deficiencies were identified. - Financial statements are based on accounting standards prescribed by ICAI; these are not internationally and widely accepted accounting standards and auditing practices. - Convergence with IFRS for banks is scheduled to commence from April 2013 onwards. - In India, standards on financial instruments (AS 30, 31 and 32) have not been notified and are therefore not binding. - To fill gaps, RBI issues prudential guidelines on investment classification and valuation, and on income recognition, asset classification, and provisioning. - RBI does not have access to external auditors’ working papers. - Recommendation: RBI should increase interaction with external auditors. ### Corrective and remedial powers of supervisors — scope and gaps - RBI has broad discretion in remedial actions, a prompt corrective action regime, and tools for problem bank resolution. - Gaps, particularly for public banks: 1. RBI cannot disempower a public bank to carry on banking activity. 2. Within the Prompt Corrective Action regime, discretion can allow a bank to operate for potentially in excess of a year with extremely low capital; given the CRAR is a total capital concept, a 3 percent total capital level could involve very little (common) equity. 3. RBI can appoint the chief executive officer or additional directors for a problem bank, but these persons are not granted additional powers; RBI should provide greater clarity to these roles. ### Consolidated supervision — progress and remaining deficiencies - RBI has broadened supervisory focus toward consolidated groups via the FSDC and subcommittee structure, regular inter-agency meetings, norms for consolidated organization, and supplemental consolidated returns. - Remaining gaps: 1. RBI cannot order inspections of, or require reports from, domestic nonbank subsidiaries it does not regulate; a proposed amendment (new Section 29 (A) of the Banking Regulation Act, Power in Respect of Associated Enterprises) would address this deficiency if enacted. RBI also cannot undertake transaction testing at such subsidiaries. 2. RBI does not receive inspection reports directly from nonbank supervisory agencies; timeliness and regularity should be improved compared to current practice of obtaining such reports from the parent bank during annual financial inspection. 3. Opportunities to improve inter-agency meetings: - Ensure meetings take place on a fully regular schedule (for both designated conglomerates and other banking companies with substantial non-banking operations). - Provide for portions of the meetings to be regulators-only to allow candid conversation. 4. RBI should consider its methodology for rating banking companies to explicitly reflect issues that may arise at nonbank subsidiaries. *Source: _cr1308 - 4. Transfer of significant* ### 5. There are major gaps in home/host information sharing arrangements ### 5. There are major gaps in home/host information sharing arrangements ### Summary of findings - The significant and growing overseas operations of Indian banks and the extent of foreign bank presence in India necessitate that RBI significantly strengthen their channels of communication and coordination with overseas supervisors. - With Indian banks having overseas operations in more than 45 jurisdictions, but RBI having MOUs with only two, and informal information sharing arrangements to varying degrees with only a few others, there are material gaps in the flow of information. - RBI has not filled those gaps through other means such as by doing overseas inspections; it has not done any overseas inspections since one was done in May 2008. - RBI has also not reached out to the host jurisdictions through the hosting of any supervisory colleges. - Given that the jurisdictions in which Indian banks operate include a number of countries in unstable regions and/or where it cannot be assumed that strong local supervisory practices have always taken strong hold, reaching out to the range of host supervisors for increased supervisory dialogue seems most appropriate. - RBI also does not clearly assess during the licensing process whether the home countries of foreign banks seeking to open offices practice consolidated supervision, nor does it carry out the analysis of the quality of host country supervision through a rigorous and consistent analytical process. - With RBI now represented on the G-20, the FSB, and the Basel Committee on Banking Supervision, the opportunity exists to influence the direction of global policy. The capacity to do that would be enhanced with some structural changes within RBI to prepare representatives at the various meetings through better coordination and focus between the various Departments within RBI. ### Key recommended actions (selected, from Annex Table 6) - Home-Host relationships (CP 25) - Promptly address material gaps in the flow of information through the execution of MOUs or other means with overseas hosts. - Consider hosting supervisory colleges for Indian banks with major international presence. - More clearly assess during the licensing process whether the home countries of foreign banks seeking to open offices practice consolidated supervision and do so through a rigorous and consistent framework of analysis. - Consider changes to prepare representatives for participation in the various international forums and working groups in which RBI participates through better coordination and focus between the various departments within RBI. - Consolidated Supervision (CP 24) — related items that address information gaps: - Empower RBI to require inspections of, or require reports from, domestic subsidiaries that it does not regulate; and to receive inspection reports directly from nonbank supervisory agencies. - Improve the process of inter-agency meetings by: - a. Ensuring that they take place on a fully regular schedule (for both designated conglomerates and other banking companies with substantial non-banking operations); and - b. Providing for the opportunity for candid conversation that would arise from portions of the meetings being regulators-only. - Conduct overseas inspections on a considerably more regular basis. - Supervisory Techniques (CP 20) - Improve the monitoring of foreign operations through better information flow from overseas supervisors and/or more overseas inspections. - Licensing Criteria (CP 3) - Require more clearly that a foreign bank applicant is subject to overall consolidated supervision in its home country. - Consider the inclusion of a requirement for ongoing information exchange with the home country supervisor as a condition for licensing an office of a foreign bank. ### Authorities’ response (selected excerpts and commitments) - RBI welcomes the comprehensive review and recognizes several gaps, notably international supervisory information sharing and cooperation; consolidated supervision of financial conglomerates; and some limits on the de jure independence of RBI. - RBI states it has information sharing arrangements with four jurisdictions and MOUs with another 12 jurisdictions are expected to be reached shortly, and that informal arrangements exist with major jurisdictions for information sharing. - RBI indicates efforts are on to establish appropriate information sharing networks as quickly as possible and that efforts are also on to establish supervisory colleges. - RBI recognizes the moral hazard issues posed by appointment of an RBI officer as a nominee director on the Board of banks and notes legislative amendments and transitions in practice, and that the matter has been taken up with Government of India for amendment of the enabling provisions of the Act. - RBI explains deviations from international norms on large exposure limits as driven by development needs and the requirement to finance major corporate groups and infrastructure. *Source: IMF Financial Sector Assessment documentation (India), chapter "5. There are major gaps in home/host information sharing arrangements"; canonical source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr1308.pdf* ### 110. This assessment of India’s observance of the IAIS Insurance Core Principles ### This assessment of India’s observance of the IAIS Insurance Core Principles (ICPs) ### Assessment scope and methodology - The assessment was carried out as part of the 2011 FSAP and employs the 2003 version of the IAIS Insurance Core Principles and Methodology, based on the essential criteria listed in that document. IAIS standards and guidelines were also taken into account, and peer review opinions were referenced where the Methodology did not support a clear finding. (Paragraph 110) - IRDA has principal responsibility for insurance regulation and supervision in India; the central government retains some reserve supervisory powers. The assessment is based on information made available to the assessor in preparation for and during the June 2011 FSAP mission. IRDA contributed its 2009 self-assessment and a detailed update at the individual criterion level. Required documentation, including all relevant laws, regulations, and circulars, was available on IRDA’s website and in the Insurance Act Manual provided to the assessor by IRDA management. (Paragraph 111) - The assessment was informed by discussions with IRDA staff, insurance companies, reinsurers, industry bodies, the actuarial and accounting professions, and relevant MoF officials. (Paragraph 112) ### Institutional and market structure — overview - Life insurance assets under management to GDP: 16.8 percent (84 percent of which is contributed by LIC). (Paragraph 113) - Real compound annual growth rates, 2005/6 to 2010/11: - Life premiums: 13.4 percent. - Non-life premiums: 6.8 percent. (Paragraph 113) - Drivers of growth: - High life premium growth since 2005 largely driven by stock market performance and popularity of unit-linked single premium contracts. - Non-life premium penetration relatively static due to price competition following removal of premium tariffs for non-mandatory insurance products in 2007. (Paragraph 113) - Life sector structure at assessment time: - 23 life insurers, including state-owned LIC. - All privately owned life insurers began operations after 2001. - Foreign shareholding caps: 26 percent of issued equity under the current Insurance Act. - Two private life insurers are 100 percent domestically owned. - Approximately half of private life insurers making accounting losses; LIC dominates due to distribution capacity, balance sheet strength, and an explicit government guarantee under its Act. (Paragraph 114) - Non-life sector composition at assessment time: - 19 multi-line insurers, three health insurers (all joint ventures), one agricultural insurer, one credit insurer. - 26 percent maximum foreign holding applies to non-life insurers. - Four non-life multi-line insurers are publicly owned; thirteen private multi-line non-life insurers are joint ventures between local enterprises and international groups; two are owned by local promoters. - Concentration indicators healthier than for the life sector, though public sector still dominates. (Paragraph 115) - Reinsurance: - One public reinsurance company (former holding company for the four non-life public insurers). - It includes a 10 percent compulsory local cession and is developing an international portfolio. - No international reinsurers have established local branches; most maintain representative offices. (Paragraph 116) - Product approval and supervisory powers: - All new or modified insurance products require supervisory sign off; IRDA can specify key product parameters, including expense loadings. (Paragraph 117) - Capital and solvency: - Minimum establishment capital for a specialist direct writer: INR 1 billion (approximately US$20 million). - Minimum establishment capital for a reinsurer: twice this (i.e., INR 2 billion). - Insurers required to report solvency quarterly; solvency certified annually by the appointed actuary. - Minimum solvency broadly in line with European Solvency I regime (aggregate approximately equal to the minimum solvency requirement under the Quantitative Impact Study 5 of Solvency II). - In practice insurers required to maintain a minimum capital of 150 percent of the statutory solvency amount. - No explicit corrective action ladder tied to the solvency ratio under current law and regulations. - Solvency ratios at end-2009/10 were largely in the acceptable range. Life sector appears stronger than non-life sector. (Paragraph 118) - Major issues facing sector and authorities: - Stabilizing motor third-party liability results. - Putting health insurance onto a sound footing. - Raising the bar for the actuarial profession in terms of specialization. - Formulating a framework for pension unit-linked insurance products (ULIPs) that balances consumer protection and commercial viability. (Paragraph 119) ### Main findings — reasons for non-full observance and strengths - Common reasons where ICPs are not fully observed: - Legislative action required to address recognized weaknesses. The Insurance Amendment Bill (pending in parliament for three years at time of assessment) contains numerous required reforms, including treatment of reinsurers, facilitating amalgamations and transfers, appeals processes, oversight of related party transactions, introducing fines at appropriate levels, and clarifying the supervisory roles of IRDA and the central government. (Paragraph 120, bullet 1) - Some ICPs not prioritized relative to others with greater urgency and potential impact; IRDA has begun work on issues such as combating fraud and exit processes. (Paragraph 120, bullet 2) - IRDA has decided India is not yet ready for a full transition to cutting-edge international approaches due to informational and skills shortages and lack of international consensus; certain prudential ICPs fall under this heading, and IRDA will need to augment resources in core supervisory departments to introduce a rigorous corrective action and enforcement regime built on a risk-based approach. (Paragraph 120, bullet 3) - IRDA has adapted to policy decisions applying in the larger Indian context; accounting approaches, particularly for assets, come under this category. (Paragraph 120, bullet 4) - Areas of strong regulation or addressed weaknesses: - IRDA’s ongoing supervision of companies, markets, and consumers is tight and displays a strong level of control; most ICPs in these sections are fully observed. Disclosure and consumer protection are at a high level by international standards. (Paragraph 121, bullet 1) - Application of prudential requirements needs to become less reliant on informal arrangements agreed by appointed actuaries. Standards should be produced and ideally an Actuarial Standards Board established. A plan to introduce specialized certification of actuaries, particularly for non-life business, is advised. (Paragraph 121, bullet 2) ### Detailed ICP-specific observations (selected from Annex Table 7) - ICP 1 – Conditions for effective insurance supervision: - If supply continues to be an issue there may be a need to consider an appointed actuary system whereby qualified actuaries from acceptable overseas members of International Actuarial Association can gain local accreditation after a suitable period of experience and with proper references. - IRDA should regularly obtain a listing of approved auditors from ICAI. - ICP 3 – Supervisory authority: - Uncertainty regarding IRDA’s control of its funding and budget, incomplete oversight of LIC, and the central government’s reserve powers to direct activities potentially detract from supervisor’s powers and independence. - ICP 5 – Supervisory cooperation and information sharing: - The cooperation and information sharing system between the three key domestic financial sector supervisors (the former RBI High Level Committee) should be formalized. - IRDA should formalize mechanisms to advise host supervisors of actions relevant to them—e.g., requiring an insurer to close a poorly performing branch. - ICP 6 – Licensing: - The government may wish to specify maximum timeframes for IRDA to respond to applications including specifying requirements for more information. - ICP 7 – Suitability of persons: - Desirable that either a Board Nominating Committee become mandatory or the compliance officer be required to immediately advise IRDA of fit and proper details of any new directorial appointment. - Desirable that the Actuarial Certificate of Practice specify the areas in which an actuary is qualified to practice. - ICP 8 – Changes in control and portfolio transfers: - While practice achieves this, the Insurance Act would ideally state that the interests of policyholders of both insurers involved must be taken into account in assessing a portfolio transfer or merger and that an independent actuarial report should be required. - ICP 9 – Corporate governance: - Corporate Governance Guidelines are comprehensive, but monitoring appears limited. - The company secretary (relevant compliance officer) often beholden to CEO and has numerous responsibilities; external auditor is not required to report on adherence to guidelines—this additional check should be instituted. - Related party transactions should be reported on an exceptions basis by size or nature, ideally in quarterly reporting. If a related party transaction appears egregiously mispriced IRDA should seek independent advice and take appropriate supervisory action. - ICP 10 – Internal controls: - Corporate Governance Guidelines should explicitly cover internal audit function, specify a senior officer responsible, ensure sufficient resources, unfettered access to required information, sufficient independence, and direct access to the audit committee and the Board. - ICP 12 – Reporting to supervisors and off-site monitoring: - Desirable that monthly reports include more short-term risk data in addition to sales and branch/geographical development data. - ICP 13 – On-site inspection: - Recommend adding a staff member with IT system skills to full-scope inspection teams given growing role of IT. - Helpful to arrange a feedback meeting after inspection completion with managements and Boards. - For normal scheduled full-scope inspections a three or four year cycle is adequate. - ICP 14 – Preventive and corrective measures: - IRDA does not have a modern risk-based early warning system; measured ratios appear largely generic rather than based on emerging experience. Supervisor is examining the Northern European traffic light system. - Concern that IRDA does not have a direct role when insurers engage in capital management such as buy-backs; this should be rectified in any Amendment Bill. - ICP 15 – Enforcement or sanctions: - Enforcement actions and sanctions open to IRDA tend to be at extremes—relatively light or very heavy. - IRDA needs to refer certain fundamental corrective actions, such as appointing an administrator, to the central government. - Corrective actions regime needs formalizing through a ‘Supervisory Guide’ or Ladder of Intervention to provide stronger legal backing. - Financial sanctions available are outdated and need to become relevant to modern scale of insurers and impact of inflation. - ICP 16 – Winding-up or exit from the market: - Authorities may wish to consider allowing voluntary wind-up of solvent non-life insurers, subject to safeguards. In some circumstances claims run-off can be most efficient method of exit. - Desirable that provisions relating to appointment of an administrator for non-life insurers be brought into line with those for life insurers. - ICP 17 – Group-wide supervision: - India has made a good start on creating a conceptual framework for conglomerate group supervision (and oversight of systemic risk) but information flows, processes, and early warning mechanisms need formalization, possibly through an MOU among the four supervisors if a coordination body with statutory status is not desirable. - Individual supervisors should have more power to consider group structures, exposures, and related party transactions in determining interventions. - Ideally an ad hoc committee of an insurer’s directors (majority independent) should, by law, consider each related party transaction to ensure market prices applied and transaction is in insurer’s interest. - ICP 18 – Risk assessment and management: - Assessment based on control of investment and underwriting risk; further work needed on monitoring operational (including general systems) risk—see Internal Control (ICP 10). - ICP 20 – Liabilities: - The need for life appointed actuaries to determine valuation discount rates through informal agreement is undesirable. - Expense over-runs should be provided for if they appear chronic once the establishment period is finished. - Basic liability methodology adopted is sound in practice. - Non-life valuation rules do not provide guidance as to where claims provisions should be set on the distribution of possible results. - ICP 21 – Investments: - In a high interest rate environment the investment valuation basis is potentially inconsistent with the Insurance Act, which states that no asset may be held above its market value. - Required skills and experience of investment officers should be specified, broadly, and subject to Board oversight. - ICP 22 – Derivatives and similar commitments: - If IFRS is fully implemented for insurers, value of debt holdings will fluctuate and derivatives may become more attractive to stabilize results; IRDA would need to strengthen governance oversight and perhaps require monthly reporting of exposures. - ICP 23 – Capital adequacy and solvency: - Solvency II Quantitative Impact Studies demonstrate Solvency I levels of capital are inadequate. - IRDA has recognized this with a non-intervention 150 percent solvency ratio requirement. - This has not been translated into a mandatory corrective action process and has been weakened already for the non-life sector. - Rating largely reflects informal solvency testing system in process of adoption, nature of ownership of Indian insurers, need for insurers to examine asset-liability matching, and ongoing oversight role of actuarial profession. - ICP 20 identified prudential shortcomings in non-life sector. - Desirable that economic capital calculation is formalized, possibly as an adjunct to corrective action regime being examined. - ICP 24 – Intermediaries: - As insurance brokers become more important statutory reporting should be upgraded; an annual or six-monthly report showing premiums collected, commissions received, amounts forwarded to insurers, and amounts held in policyholder trust funds would provide more focused risk information. - ICP 25 – Consumer protection: - The 12 Ombudsmen do not communicate and there may be grounds for establishing a mechanism to share experiences and observations. - ICP 27 – Fraud: - Fraud is a growing issue, particularly in health insurance. Preventive actions are being adopted by individual insurers but there has been little industry-wide response; relevant IRDA guidance is still to be developed and promulgated. - ICP 28 – Anti-money-laundering, combating the financing of terrorism: - Advisable that the growing role of brokers be addressed through a new directive. - Financial sanctions need strengthening for legal person intermediaries, but the existing name-and-shame option is likely to be effective in the interim. *This assessment of India’s observance of the IAIS Insurance Core Principles (ICPs) was carried out as part of the 2011 FSAP and is based on material provided to and reviewed by the assessor during the June 2011 mission.* ### Annex Table 8. India: Recommended Action Plan to Improve Observance of the ### Annex Table 8. India: Recommended Action Plan to Improve Observance of the Insurance Core Principles ### Recommended actions by ICP - ICP 3 – Supervisory Authority - The Insurance Amendment Bill needs to be passed and become effective so as to ensure that IRDA is clearly independent and has a wider range of direct powers of intervention. - Greater transparency over the early departure of senior officers is required. - ICP 15 – Enforcement or Sanctions - The enforcement regime needs to be formalized through a regulatory ‘Supervisory Guide’ or ‘Ladder of Intervention’ so as to provide IRDA with stronger legal backing when it intervenes and to limit the scope for forbearance. - Additional intermediate enforcement powers could include: - The ability to impose selective time and volume limitations on business activities (including by geography and product); - The ability to require deposits if assets security is a concern; and - The ability to impose an expiry date for a license to encourage timely rectification of undesirable financial ratios or operating practices. - Financial sanctions need to be updated to reflect the impact of inflation since the fines were first established. - ICP 20 – Liabilities (non-life) - IRDA should provide guidance as to where long tail provisions should be set on the distribution of possible results. - Ideally the non-life actuary should provide a range of possible values to management and Board and show where, say the 75th percentile value lies. - Non-life Appointed Actuaries should be certified on the basis of training and experience in this very specialized area. - ICP 27 – Fraud - Continue the development of fraud control systems. ### Authorities’ response — overall assessment and context - Institutional history and mandate - IRDA was set up under an Act of Parliament in the year 2000. - The Authority has objectives of both regulation and development of the insurance sector in India. - The insurance sector in India has witnessed significant progress over the period 2000/11. - Supervisory and regulatory framework has been built to match international standards while adapting to Indian jurisdictional needs. - De jure independence concerns - Legislation provides for certain powers to be vested with the central government; these are described as “reserve” powers to be invoked in emergent situations and not intended to impinge on IRDA’s independence. - IRDA maintains it has statutory responsibility for regulation and supervision of the insurance sector in India. ### Life insurance industry — findings and responses - Market structure and concentration - Since opening to private participation in 2000, 23 life insurance companies have been granted registration to underwrite insurance business in the country. - The life insurance industry is concentrated relative to the pre-2000 monopoly of LIC; LIC’s market share had steadily declined post-opening up, except in the last one year or so due to market corrections after directions on ULIPs. - Oversight of LIC - Supervisory and regulatory framework constitutes a level playing field for private and state-owned insurers. - Oversight of LIC is comprehensive in prudential matters and market conduct. - Government of India is examining recommendations of the expert group set up in August 2010 to examine LIC’s functioning. - Unit Linked Insurance Plans (ULIPs) - From 2005, significant growth in ULIPs coincided with bullish stock market conditions; growth led to practices deemed imprudent. - In 2010, IRDA issued stipulations on ULIPs and Variable Insurance Products. ### Non-life industry — findings and responses - De-tariffing and underwriting performance - Prior to 2007, the non-life market was predominantly under Tariff Price; catastrophic events impacted performance in 1998, 2001, 2005. - In 2007, Tariff pricing model was dismantled (except Motor Third Party Insurance) to encourage competition and risk-based pricing. - Post de-tariffing, price levels dipped and underwriting performance deteriorated; with 24 non-life insurers competing and the last four years being benign, prices dipped steeply. - IRDA reviews pricing methods under file-and-use procedures and ensures Appointed Actuary certifies adequacy and viability. - Remedial and supervisory actions - IRDA has advised insurers via the General Insurance Council to review pricing philosophy and standards. - IRDA initiated review exercises on underwriting performance of individual companies and examines adequacy of Reserves for Claims through interaction with appointed actuaries. - Health insurance challenges - Growth of gross premium in health insurance has been over 30 percent year-on-year in the last five years. - Third Party Administrators have facilitated claims servicing; initial data capture was insufficient. - IRDA facilitated capture and transfer of data in a prescribed format to the Insurance Information Bureau (initiative of IRDA and General Insurance Council); the Bureau has started publishing analytical results and is enhancing data quality. - IRDA is deploying a software tool to detect probable fraud cases and assist insurers; regulatory framework on detection, classification, monitoring, reporting and mitigation of frauds is being put in place. - Government role and restructuring - Government is examining its role and strategy in non-life market; a White paper on alternatives (including merger, partial disinvestment) has been circulated. - A key challenge is dealing with a huge workforce of over 70,000 employees in the four direct insurance companies. - Two of the companies have better financial credentials while two do not. - Motor Third Party Insurance Pool - A recent review of reserves for claims under the Indian Motor Third Party Insurance Pool for commercial vehicles led to correction that dipped solvency levels of two companies; Authority has informed Government. - IRDA directed an increase in price of Motor Third Party Insurance and issued directions: - Dismantling the existing Indian Motor Third Party Pool with effect from March 31, 2012; and - Setting up the framework for Motor Third Party Declined Risk Insurance Pool for commercial vehicles. ### Investments and risk responsibilities - Investment oversight - IRDA has mechanisms for investment of insurer assets; exposure limits at company, group, and industry levels are prescribed. - Responsibility for compliance rests with the Investment Committee of the insurer, with audit oversight and reporting to Boards. - Authorities feel no additional oversight is required specifically for bank exposures. ### Solvency requirements and corrective mechanisms - Statutory and regulatory solvency - The statute stipulates solvency of 100 percent. - IRDA’s registration requirements stipulate solvency requirements at 150 percent which must be complied with at all times. - IRDA does not envisage the need for a ladder approach to intervention levels. - Risk-based oversight developments - IRDA is working on early warning signals to enable quick action based on regular monitoring. - IRDA is examining issues related to moving towards a risk based approach to solvency (on lines similar to the European Union) and will deliberate with stakeholders before deciding. ### ICP-wise assessment comments (selected) - ICP 1 – Conditions for effective insurance supervision - Minimum eligibility criteria for appointment of statutory auditors of insurance company have been put in place. - IRDA will not maintain a list of approved auditors from ICAI. - The IRDA (Appointed Actuary) Regulations, 2000 set eligibility for Appointed Actuaries; IRDA is examining accreditation of qualified actuaries from acceptable overseas members of the International Actuarial Association with Institute of Actuaries of India and is consulting stakeholders. - ICP 3 – Supervisory authority - Regulatory oversight on LIC is comprehensive though LIC Act excludes applicability of certain provisions of Insurance Act, 1938. - Concerns about reserve powers of Central Government are reiterated as unfounded; such powers are for emergent situations. - Section 5 and 6 of the IRDA Act provide procedures for appointment and removal of Chairman and other members; appointments and removals by Government of India are notified in the official gazette. - ICP 5 – Supervisory cooperation and information sharing - IRDA has applied to be a signatory to the Multilateral Memorandum of Understanding (MMOU) with the IAIS to enable exchange of information with other regulators. - ICP 6 – Licensing - Timelines for registration of intermediaries (brokers, corporate agents, third party administrators) are specified in IRDA Regulation. - Government-prescribed timelines for registration of new insurance companies may be inappropriate given due diligence and ‘fit and proper’ judgments required. - IRDA is exploring publishing the status of all entities’ requests on the IRDA website to improve licensing transparency. - ICP 7 – Suitability of persons - Insurance Act, 1938 requires CEO and executive directors be appointed with IRDA approval; Corporate Governance guidelines assign Board responsibility for fit and proper compliance. - IRDA is examining stipulations requiring insurers to intimate IRDA on compliance with fit and proper requirements for appointment of new Directors (details for non-Executive Directors to be filed with IRDA). - Recommendation: Actuarial Certificate of Practice should specify the area in which the Actuary is qualified to practice; recommendation forwarded to Institute of Actuaries of India and views are awaited. - ICP 8 – Changes in control and portfolio transfers - It has been recommended that Insurance Law explicitly state that interests of policyholders of both insurers involved must be taken into account in assessing portfolio transfer/merger and that an Independent Actuarial report should confirm the same. *Source: Annex Table 8. India: Recommended Action Plan to Improve Observance of the Insurance Core Principles* ### Section 35 of the Insurance Act, 1938 deals with amalgamation and transfer of life ### _cr1308 - Section 35 of the Insurance Act, 1938 deals with amalgamation and transfer of life ### Amalgamation and transfer of life and non-life insurance business - Section 35 of the Insurance Act, 1938 deals with amalgamation and transfer of life insurance business. - The IRDA (Scheme of Amalgamation and Transfer of General Insurance Business) Regulations, 2011 lay down the framework for Mergers and Amalgamation of non-Life insurance companies. - The underpinning of the regulatory framework is protection of the interests of the policyholders. - IRDA will examine recommendations and, if considered necessary, incorporate explicit stipulations that interest of policyholders of both insurers involved must be taken into account in assessing the portfolio transfer/merger. ### ICP 9 – Corporate governance - Authority will examine proposal to enhance the scope of the statutory auditor’s report to cover compliance with the corporate governance guidelines; reporting could form part of the Auditor’s Report attached to the financial returns filed annually. - Recommendation: related party transactions should be reported to the Authority ideally as part of monthly reporting. - Accounting Standard 18 (AS-18) issued by ICAI deals with related party transactions; statutory auditors required to comment on arm’s length of such transactions. - Insurance companies required to make disclosures on related party transactions on an annual basis. - Decision on strengthening oversight and reducing periodicity of reporting will be based on discussions with other financial sector regulators. ### ICP 10 – Internal control - Recommendations to strengthen internal control and internal audit under corporate governance guidelines. - IRDA’s position: - Internal control and internal audit are mandated under the regulatory framework and corporate governance Guidelines. - Statutory auditors and the audit committee have oversight; statutory auditors required to comment on adequacy of internal controls. - All insurance companies have internal audit departments headed by senior-level executives; internal audit carried out through in-house/outsourced personnel. - Authority does not consider it necessary to mandate that internal audit must be carried out by an internal department. - Authority will examine the existing framework and the corporate governance guidelines, if necessary. ### ICP 12 – Reporting to supervisors and off-site monitoring - Recommendation: monthly reporting could include more short term risks and additional data beyond sales and branch/geographical development data. - Annual Appointed Actuary’s Report requires insurance companies to cover the risks faced by them. - Proposal: make such reporting robust to cover all risks faced by an insurance company. - Once the mechanism stabilizes, it is proposed to reduce the periodicity to half yearly. ### ICP 13 – Onsite inspection - Comments made on making onsite inspection more robust. IRDA comments: - Inspection teams are well formed including inspectors from major areas required and include a systems person as part of full scope inspection teams. - Mechanism in place to share inspection team reports with the insurance company. - Internal Standing Committee deliberates on inspection findings and management responses prior to final action on regulatory issues. - Proposal to build necessary onsite inspection capacities within IRDA to ensure full financial audit at a periodicity of 3–4 years for each company; inspections may be carried out at shorter intervals if warranted. ### ICP 14 – Preventive and corrective measures - IRDA working on strengthening preventive and corrective measures through an early warning system to facilitate early intervention in case of an emerging regulatory concern. - IRDA proposes mechanism to require its concurrence/compliance with certain prerequisites when an insurer proposes capital management actions such as ‘buy-back’ of shares. ### ICP 15 – Enforcement of sanctions - Section 102 of the Insurance Act, 1938 enables IRDA to levy a penalty of INR 5 lakhs for each instance of violation without any overall ceiling or cap. - Insurance Amendment Bill, 2008 proposes to increase the quantum of penalty leviable on insurers for various violations, with the maximum penalty proposed to be raised to INR 25 crore. - Authority takes enforcement decisions based on severity and outcome of a violation. ### ICP 16 – Winding-up and exit from the market - Recommendation: IRDA may consider allowing voluntary wind up of solvent non-life insurers, subject to satisfactory safeguards. - In some circumstances claims run off can be the most efficient method of exit. - Recommendation: bring provisions relating to appointment of an Administrator for non-life insurers into line with those applying to life insurers. - Authority is examining these recommendations. ### ICP 17 – Group-wide supervision - Recommendation on formalizing information sharing mechanism addressed under ICP 5. - Subcommittee of FSDC has mandate to examine information sharing and coordination between financial sector regulators. - Issues on supervisors having greater power to consider group structures, exposures, related party transactions, and intervention to be taken up by the subcommittee. ### ICP 18 – Risk assessment and management - IRDA’s view on proposed reporting framework for risks is outlined under ICP 12. - Proposal: dovetail internal audit/control functions and corporate governance guidelines to ensure robust risk assessment and management framework. - Addressing operational risks is at top of IRDA’s agenda. - Stipulations on Asset Liability Management mandated for all insurance companies effective April 1, 2012. ### ICP 20 – Liabilities - FSAP mission recommendations on valuations of liabilities for life and non-life insurers are broadly twofold: - Need for life actuaries to compensate difference between the philosophies underlying the liability and asset valuation undesirable; expense over-runs should be provided for if they appear to be chronic once the establishment period is finished. - Non-life valuation rules do not provide guidance on where long tail provisions should be set on—distribution of possible results. - IRDA set up Actuarial Standing Committee vide Order No. IRDA/ACT/ORD/MISC/131/06/2011 dated June 21, 2011, to advise on actuarial standards/regulations; recommendations forwarded to the Standing Committee. ### ICP 21 – Investments - Mission noted contradiction in valuation of debt instruments: not being valued at not exceeding their market or realisable value as provided under section 64V of the Insurance Act, 1938. - Authority decision: investments by insurance companies are long term and valued at acquisition cost subject to provision for nonperforming assets. - On required skill and experience of investment officers: IRDA views these requirements fall within the mandate of the Investment Committee under oversight of the Board; stipulations on Investment Committee constitution laid down under regulatory framework. ### ICP 22 – Derivatives and similar commitments - Reporting mechanism for derivatives exposure by insurance companies will be strengthened. ### ICP 23 – Capital adequacy and solvency - IRDA working on early warning signals. - Insurance Act requires insurance companies to maintain solvency of 100 percent. - As part of registration requirements, Authority stipulated all insurance companies must maintain a solvency of 150 percent at all times. - IRDA has laid down stipulations on computation of economic capital by life and non-life companies. - Institute of Actuaries of India released guidance on embedded value calculations for life insurance companies. - IRDA examining merits of moving toward a standardized risk based solvency model with the aim that the capital adequacy and solvency regime would become risk based as initiatives stabilize. ### ICP 24 – Intermediaries - Recommendation: upgrade statutory reporting as insurance brokers become more important. - Only reinsurance Brokers permitted to collect and remit premiums (Reg. 4 (j)); provisions on segregation of insurance money and Insurance Bank Account relate to Reinsurance Brokers (Reg. 23). - Reporting requirements in place: licensed insurance brokers must submit premiums placed to insurance companies segment-wise and brokerage received; brokers must file annual audited accounts and half yearly unaudited accounts. - Direct insurance brokers not permitted to accept insurance premiums in their account, except reinsurance brokers; therefore, there are no policyholder trust funds. - Insurance brokers required to have professional indemnity cover. - Reporting norms for reinsurance brokers about amounts held in reinsurance accounts can be examined by the Authority. ### ICP 25 – Consumer protection - Recommendation on strengthening the framework on Ombudsman is under consideration by the Government of India; IRDA will provide necessary inputs. ### ICP 26 – Information, disclosure, and transparency toward the market - IRDA proposing to work on snapshot of financial performance parameters to be disclosed by insurance companies at an annual periodicity, which may be further shortened. ### ICP 27 – Fraud - IRDA working on regulatory framework on frauds for the insurance sector. - Mechanism aims for insurance companies to have robust frameworks to address, monitor, mitigate risks from frauds, and reporting of frauds for life, non-life, and reinsurance companies. ### ICP 28 – AML/CFT - Recommendation: insurance brokers should be brought within purview of AML/CFT guidelines. - Percentage of business procured through brokers is very low at around 1 percent for life insurance companies; broker presence is much more significant for non-life insurance companies. - Authority is examining proposal to bring brokers under AML/CFT guidelines. - Issues relating to financial sanctions being enhanced addressed under ICP 15. *Source: _cr1308 - Section 35 of the Insurance Act, 1938 deals with amalgamation and transfer of life* ### 145. MCA and RBI have certain responsibilities in the regulation and supervision of ### _cr1308 - 145. MCA and RBI have certain responsibilities in the regulation and supervision of ### Regulatory responsibilities and division of authority - SEBI reviews the prospectus of listed issuers and regulates listed companies in respect of issue, transfer of securities, and nonpayment of dividend. - MCA has authority to register and regulate all companies (except listed companies in respect of issue, transfer, and nonpayment of dividend), and it is currently the main authority in charge of reviewing the annual financial reports (including financial statements) that all companies, including listed issuers, are required to submit pursuant to the Companies Act. - RBI has regulatory responsibility over contracts on government securities, gold-related securities, and money market securities (and securities derived from those securities), and repo contracts in debt securities. - Execution of those contracts on exchanges is under the responsibility of SEBI. - Several channels have been created to foster inter-agency coordination though many of them are recent developments and therefore are still evolving. ### Role of Recognized Stock Exchanges (RSEs) and self-regulation - RSEs are the listing authorities and are in charge of monitoring issuers’ compliance with disclosure obligations. - Under listing agreements RSEs operate as the primary regulator and supervisor for brokers. - RSEs are in charge of real time surveillance of the markets that they operate. - In practice these functions have mainly rested with the two nationwide RSEs, the BSE and the NSE. - SEBI oversight mechanisms for RSEs include periodic reporting, regular meetings on market developments, annual onsite inspections, and a recently constituted committee on noncompliance with listing obligations. ### Market structure and statistics - As of June 2011, there were 5,025 listed companies in the BSE. - Market capitalization amounted to 87 percent of GDP (as of June 2011). - As of 2011, the top 10 companies represented 31 percent of total market capitalization. - Corporate bond markets: the bulk of debt offerings are private offerings; data available for privately placed issues listed on exchanges under The Debt Regulations and for corporate bonds issued in dematerialized form from CDSL and NSDL. - Derivatives markets: derivatives turnover has been substantially higher than cash equity turnover; trading in derivatives is dominated by the NSE, which has a share of more than 99 percent of total turnover. - For the last two years (relative to the report) the largest share of total derivatives turnover has been in index options, with a 45.5 percent share. - As of March 2010 there were 10,203 brokers authorized to trade on a RSE. - Corporate brokers constitute 90 percent of brokers at NSE and 82 percent at BSE. - There were 192 merchant bankers and three underwriters registered with SEBI. - There were 267 portfolio managers registered with SEBI; portfolio managers are only authorized to manage individual accounts and cannot pool the money of investors. - Equity markets listing and secondary market trading are concentrated in two out of 21 RSEs—the BSE and the NSE. - Both RSEs operate anonymous order-driven systems and settlement takes place on a t+2 basis. - Clearing in both the NSE and the BSE is done through CCPs: - NSE: NSCCL, a wholly owned subsidiary of the NSE, performs CCP services. - BSE: Bank of India Shareholding Limited facilitates settlement by coordinating with clearing banks and depositories as per directions of the exchange; BSE Ltd. acts as the central counterparty and guarantees settlement for equity cash segment and delivery based stock derivatives. - ICCL handles the mutual fund segment and the corporate bond segment of BSE Ltd., and the currency derivatives segment of USE Ltd. ### Preconditions for effective securities regulation - No significant barriers to entry and exit for market participants. - Foreign ownership of securities intermediaries is allowed, but investment by foreign investors in Indian issuers and mutual funds must be done through FIIs, which are required to register with SEBI. - Since August 2011, SEBI has allowed foreign investors who meet “know your customer” requirements to invest in equity and debt schemes of mutual funds. - The Companies Act contains a basic framework for the constitution and operation of corporations that could usefully be updated. - Market participants identified the insolvency regime as requiring a major overhaul; protracted insolvency proceedings are mentioned as a key weakness. - A Companies Bill 2011 has been tabled in Parliament (authorities informed). - Criminal enforcement in the courts is a challenge, with protracted procedures mentioned as the main problem. - The country is moving toward convergence with (rather than adoption of) IFRS; IFRS equivalent standards have been notified by the central government and ICAI has suggested April 2013 for implementation. - Some differences with IFRS remain; the authorities intend to initiate a dialogue with the International Accounting Standards Board to address such differences. - Market participants expressed concerns about the taxation framework, in particular the existence of a securities transaction tax with different percentages for different asset classes, which can distort market development. - The MoF has initiated a review of such tax with a view towards rationalization of securities transaction tax percentages (authorities informed). - General concerns about the level of corruption in the country; creation of an independent anticorruption agency is currently being discussed in parliament. ### Main findings (summary of assessment against IOSCO Principles) - Principles for the regulator (1–5): - SEBI‘s responsibilities are clearly established by law. - Several coordination mechanisms with other domestic authorities exist, many of recent creation and still evolving. - SEBI has acted with a high degree of independence from governmental and commercial interest. - SEBI has broad licensing, supervision, investigation, and enforcement powers. - Challenges: number of staff vis-à-vis market size; capacity to hire personnel with market experience, especially at senior level. - Regulatory development is subject to public consultation; licensing requirements established by regulations available on SEBI’s website. - Parties affected by SEBI decisions have a right to appeal. - Code of conduct for staff includes provisions on use of information, transactions in securities, gifts, and cool-off periods; separate provisions exist for Board members. - Principles for enforcement (8–10): - SEBI has broad authority to request information, testimony, and conduct inspections on regulated entities and third parties. - SEBI can impose a wide range of measures and sanctions including cease and desist orders, money penalties, and disgorgement. - Onsite inspection plans require further strengthening, particularly for securities intermediaries; enforcement of listing obligations by issuers and of accounting and auditing standards also needs strengthening. - While law provides for strong criminal penalties, in practice effective criminal enforcement has focused on CIS cases. - Principles for cooperation (11–13): - SEBI’s Act provides authority to cooperate and share public and nonpublic information with domestic and foreign authorities, without limitations. - SEBI is signatory of the IOSCO MMOU and several bilateral MOUs and has demonstrated effective cooperation with foreign regulators. - Principle for issuers (14–16): - Public offering of securities is subject to disclosure requirements, mainly via a prospectus broadly in line with IOSCO principles. - SEBI reviews all prospectuses of equity issuers; RSEs review those of debt issuers. - Periodic requirements on listed companies include prompt disclosure of material events. - Mechanisms to ensure compliance with listing obligations (including periodic reporting) are a responsibility of the RSEs; such mechanisms have limitations. - A committee on noncompliance of listing agreement has recently been set up. - Issuers must submit financial statements according to local accounting standards; auditors required to conduct audits based on local auditing standards. - Mechanisms to ensure compliance with accounting and auditing standards including auditors’ independence have limitations. - Principles for collective investment schemes (17–20): - Robust registration requirements for sponsors and asset management companies. - Individuals who want to sell CIS are subject to a certification process. - Mutual funds and asset management companies are subject to offsite reporting. - Starting in 2011/12, SEBI enhanced its supervisory approach with SEBI staff carrying out inspections under a risk-based approach; thematic inspections are becoming integral to the supervisory plan. - Asset management companies must submit a prospectus for every mutual fund scheme; content broadly in line with IOSCO principles. - Assets of mutual funds must be entrusted to an independent custodian. - Clear rules on valuation, including detailed guidelines for valuation of illiquid securities; for debt assets must be valued using prices provided by independent third parties. - Asset management companies are responsible to investors for errors in valuation. - Principles for market intermediaries (21–24): - Robust registration requirements for all types of securities intermediaries. - RSEs do not conduct visits in connection with broker registration. - Portfolio managers had not been subject to regular inspections but are inspected every three years upon renewal of registration; SEBI implemented a more comprehensive inspection program for merchant banks recently. - Inspections have been compliance based; follow up of inspection findings should be strengthened. - All intermediaries except merchant banks and underwriters must submit semiannual audits of internal controls and risk management systems. - All intermediaries must appoint compliance officers. - RSEs have established early warning mechanisms for brokers and detailed provisions to deal with broker failure. - Principles for secondary markets (25–30): - Only RSEs can operate in India, subject to recognition by SEBI. - Recognition requirements are robust and include economic resources and certifications of IT systems. - RSEs have established robust mechanisms for market surveillance, complemented by SEBI’s surveillance system. - Market manipulation, insider trading, and other unfair practices constitute both civil infractions and criminal offenses. - RSEs have robust mechanisms to monitor large exposures by members. - A system of Market-Wide Circuit Breakers and Securities Level Price Bands has been put in place. *Source: _cr1308 - 145. MCA and RBI have certain responsibilities in the regulation and supervision of* ### Annex Table 9. India: Summary Implementation of the IOSCO Objectives and ### _cr1308 - Annex Table 9. India: Summary Implementation of the IOSCO Objectives and Principles of Securities Regulation ### Regulatory mandate, independence, and governance - Principle 1. The responsibilities of the regulator should be clearly and objectively stated - SEBI is the main authority responsible for the regulation and supervision of securities markets. - Its responsibilities are clearly stated in different legal statutes. - MCA and RBI have some limited responsibilities stemming from laws and notifications from the central government. - The RSEs also have a critical role in self-regulation. - Different mechanisms have been set up to foster coordination, including several committees; many of them are of recent creation, thus still evolving. - Principle 2. The regulator should be operationally independent and accountable in the exercise of its functions and powers - The possibility that Board members can be removed without cause is a threat to independence. - Existence of a very general provision that allows the central government to provide directions to SEBI and supersede SEBI’s Board is a threat to independence. - In practice SEBI has acted with a high degree of independence from both governmental and commercial interests. - SEBI is required to provide annual reports to the central government and parliament. - SEBI’s accounts must be audited on an annual basis by the Comptroller and Auditor General of India. - Principle 3. The regulator should have adequate powers, proper resources and the capacity to perform its functions and exercise its powers - SEBI has broad licensing, supervision, investigation, and enforcement powers. - SEBI faces challenges in regard to the number of staff vis-à-vis the size of the market and its ability to hire staff with market experience, the latter mainly due to salary limitations. - Whole time members carry a critical role of overseeing day-to-day operations of the institution. - Principle 4. The regulator should adopt clear and consistent regulatory processes - Issuance of regulations by SEBI is subject to public consultation. - SEBI has established consultative committees where the views of different stakeholders are taken into consideration. - Requirements for licensing/registration are established by regulations, which can all be found on SEBI’s website. - Parties aggrieved by a decision of SEBI have a right to appeal before the securities appellate tribunal. - Principle 5. The staff of the regulator should observe the highest professional standards - There is a code of conduct that applies to all staff, with guidelines on use of information, transactions in securities, gifts, and cooling off periods. - Separate rules for Board members impose further disclosures and additional requirements regarding management of conflict of interest. ### Use and oversight of Self-Regulatory Organizations (SROs) - Principle 6. The regulatory regime should make appropriate use of SROs that exercise some direct oversight responsibility for their respective areas of competence and to the extent appropriate to the size and complexity of the markets - The RSEs are the listing authorities, the front line regulators and supervisors for brokers, and have also a role in market surveillance. - Principle 7. SROs should be subject to the oversight of the regulator and should observe standards of fairness and confidentiality when exercising powers and delegated responsibilities - RSEs require recognition from SEBI, which can impose conditions to grant such recognition. - Conditions have included provisions to address conflict of interest, e.g., requiring independent members on the Board and specialized committees to discharge self-regulatory functions. - All bylaws of the RSEs are subject to SEBI’s approval. - SEBI has established a robust oversight regime for the RSEs, including offsite reporting, meetings, and onsite inspections, the latter on an annual basis. ### Inspection, investigation, surveillance, and enforcement - Principle 8. The regulator should have comprehensive inspection, investigation and surveillance powers - SEBI has broad powers to request information, testimony, documents, and to inspect all types of regulated entities. - Principle 9. The regulator should have comprehensive enforcement powers - SEBI has broad powers to request information, testimony, and documents from third parties, including bank records. - SEBI has broad civil enforcement powers over both regulated entities and third parties, including authority to impose cease and desist orders, money penalties, disbars, and disgorgement. - Principle 10. The regulatory system should ensure an effective and credible use of inspection, investigation, surveillance and enforcement powers and implementation of an effective compliance program - SEBI has established a system of offsite supervision for all intermediaries. - Important limitations exist in the system of onsite inspections, particularly for securities intermediaries; SEBI is implementing changes toward a more comprehensive risk-based approach. - SEBI, along with the RSEs, has established a robust system of market surveillance. - Supervision of the RSEs is robust. - SEBI is active in civil enforcement, particularly regarding unfair trading practices. - Enforcement of listing obligations (mainly a responsibility of the RSEs) requires further strengthening, as does enforcement of accounting and auditing standards. - Criminal enforcement also needs to be stepped up. ### Information exchange and cooperation - Principle 11. The regulator should have the authority to share both public and nonpublic information with domestic and foreign counterparts - SEBI Act provides SEBI with the authority to cooperate with domestic and foreign authorities and to share both public and nonpublic information. - Principle 12. Regulators should establish information sharing mechanisms that set out when and how they will share both public and nonpublic information with their domestic and foreign counterparts - Several mechanisms to foster coordination and exchange of information have been established at the domestic level; some are recent and still evolving. - SEBI is signatory of the IOSCO MMOU, as well as other bilateral MOUs, and has been active in providing information to foreign counterparts. - Principle 13. The regulatory system should allow for assistance to be provided to foreign regulators who need to make inquiries in the discharge of their functions and exercise of their powers - SEBI Act grants SEBI the authority to provide assistance to foreign regulators even if the information requested by them is not currently in its files. - SEBI has provided examples that it has done so. ### Disclosure, issuer regulation, and investor protection - Principle 14. There should be full, timely and accurate disclosure of financial results and other information that is material to investors' decisions - All public offers are subject to submission of a prospectus, the content of which is broadly in line with IOSCO requirements. - SEBI reviews all prospectuses from equity issuers; prospectuses from debt issuers are reviewed by the RSEs. - Listed companies are subject to periodic reporting: annual reports, quarterly reports (equity issuers), and semiannual reporting (debt issuers). - All listed companies must inform their RSE immediately of material events; the Listing Agreement provides guidance on events to be disclosed promptly. - Ensuring compliance with listing obligations is mainly a responsibility of the RSEs; current arrangements developed by the RSEs have important limitations. - A committee on noncompliance was set up to address this issue. - Principle 15. Holders of securities in a company should be treated in a fair and equitable manner - SEBI’s regulations require disclosure to the public of significant holdings (starting at five percent) as well as insiders’ holdings. - Regulations require a mandatory tender offer for the acquisition of control (after certain thresholds); the acquirer must submit an offering document subject to SEBI’s approval. - Current regulations do not allow the acquirer to pay promoters a higher price for their shares as used to be the case prior to a recent reform. - A difference remains: regulations allow agreement with promoters whereby in the event of a partial offer, the acquirer can acquire the complete holding of the promoters. ### Accounting, auditing, and review - Principle 16. Accounting and auditing standards should be of a high and internationally acceptable quality - Issuers are required to submit financial statements according to Indian accounting standards; the central government intends to move toward IFRS equivalent standards. - Auditors are required to carry out audits according to Indian auditing standards; the central government intends to move to international standards. - Review of financial statements of listed companies is mainly a responsibility of the MCA; information is insufficient to assert whether such review is conducted effectively or whether enforcement actions are taken when necessary. - Currently there is no independent mechanism to oversee compliance by auditors with auditing standards; the ICAI has performed a disciplinary role over them. - The government created the Quality Review Board to oversee the quality of auditors’ work, but it is not yet operational and it is not clear whether it would meet the independence requirement of the IOSCO Principles. ### Collective investment schemes (CIS) and asset management - Principle 17. The regulatory system should set standards for the eligibility and the regulation of those who wish to market or operate a collective investment scheme - Robust standards exist for the eligibility of sponsors and asset management companies and individuals who sell the products. - Mutual funds and asset management companies have been subject to offsite reporting. - Until this year all mutual funds were supervised every two years by external auditors. - Starting in 2011/12 SEBI changed its supervisory approach: inspections are to be carried out directly by SEBI staff under a risk-based approach, with higher-risk mutual funds inspected annually. - Thematic inspections are becoming integral to the inspection plan. - SEBI has used primarily warnings and letters of deficiency to address inspection findings; in a few cases it has used measures such as disgorgement and payment of money under consent proceedings. - Principle 18. The regulatory system should provide for rules governing the legal form and structure of collective investment schemes and the segregation and protection of client assets - Clear rules exist concerning the legal form and structure of CIS: currently all CIS are constituted as trusts. - Clear rules on segregation of assets exist, including the requirement of an independent custodian. - Principle 19. Regulation should require disclosure, as set forth under the principles for issuers, which is necessary to evaluate the suitability of a collective investment scheme for a particular investor and the value of the investor’s interest in the scheme - The asset management company is required to submit a prospectus to SEBI for each CIS, the content of which is in line with the IOSCO Principles; SEBI reviews all such prospectuses. - Principle 20. Regulation should ensure that there is a proper and disclosed basis for assets valuation and the pricing and the redemption of units in a collective investment scheme - Clear rules exist on valuation of assets, including illiquid assets. - For illiquid debt securities, guidelines require asset management companies to value portfolios using prices provided by an independent party (currently the credit rating agencies). - Asset management companies are responsible to cover errors in pricing. ### Market intermediaries: entry, prudential, conduct, and failure procedures - Principle 21. Regulation should provide for minimum entry standards for market intermediaries - Robust registration requirements exist for all types of securities intermediaries. - Except for brokers, registration is carried out by SEBI and includes a visit to verify systems and controls; for brokers, registration is carried out on the recommendation of RSEs, and the RSEs do not conduct visits in connection with such registration. - There is a system of offsite reporting for all intermediaries. - A comprehensive and regular plan for onsite inspections of portfolio managers has not been in place. - Only this year a more comprehensive inspection plan for merchant bankers started to be implemented. - Brokers have been subject to annual inspections by the RSEs. - Inspections have been compliance based; thematic inspections have not been a regular part of the supervisory approach. - Principle 22. There should be initial and ongoing capital and other prudential requirements for market intermediaries that reflect the risks that the intermediaries undertake - All intermediaries are subject to minimum capital requirements depending on the license they want to hold, which they should keep at all times. - There are no additional requirements to adjust capital by risk. - In practice risk exposures appear to be limited in light of the current business models of different types of intermediaries. - Principle 23. Market intermediaries should be required to comply with standards for internal organization and operational conduct that aim to protect the interests of clients, ensure proper management of risk, and under which management of the intermediary accepts primary responsibility for these matters - All intermediaries, except merchant bankers and underwriters, are required to have independent audits of their internal control and risk management systems on a semiannual basis. - All intermediaries are required to appoint a compliance officer. - All intermediaries must have a system to address investors’ complaints. - Intermediaries are required to sign contracts with investors when starting a business relationship and to provide semiannual information on the status of investments. - Know your customer and suitability obligations apply. - Principle 24. There should be a procedure for dealing with the failure of a market intermediary in order to minimize damage and loss to investors and to contain systemic risk - RSEs have established early warning mechanisms and detailed provisions to deal with the failure of brokers. - Such provisions do not exist for other intermediaries. - Strong rules on segregation of assets exist, and SEBI has broad powers to deal with the failure of such intermediaries. ### Trading systems, exchanges, market integrity, and market infrastructure - Principle 25. The establishment of trading systems including securities exchanges should be subject to regulatory authorization and oversight - Only RSEs can operate in India, subject to recognition by SEBI. - Recognition requirements include financial resources and certifications by experts of the robustness of their IT systems, among others. - All rules of the RSEs have to be approved by SEBI. - SEBI has broad powers over the RSEs, including suspension and power to revoke the authorization. - Principle 26. There should be ongoing regulatory supervision of exchanges and trading systems, which should aim to ensure that the integrity of trading is maintained through fair and equitable rules that strike an appropriate balance between the demands of different market participants - RSEs have established robust market surveillance systems and monitor the market in real time. - Given plurality of trading platforms, SEBI has established its own surveillance system to complement the RSEs; SEBI conducts its surveillance on t+1. - There is evidence that the RSEs and SEBI are active in investigations. - Principle 27. Regulation should promote transparency of trading - RSEs are required to have both pre- and post-trade transparency vis-à-vis other market participants and the public. - Principle 28. Regulation should be designed to detect and deter manipulation and other unfair trading practices - Market manipulation, insider trading, and other unfair practices are by law both a civil infraction and a criminal offense; parallel proceedings are allowed. - Together with the exchanges, SEBI has established a robust system of market surveillance aided by the requirement that all customers have one single number for transacting in the securities markets. - Criminal enforcement needs to be stepped up. - Principle 29. Regulation should aim to ensure the proper management of large exposures, default risk and market disruption - The RSEs, through the CCPs, monitor exposures on a real time basis and have robust powers to deal with exposures, including setting limits. - Brokers are required to post initial and variation margin and to contribute to a settlement fund. - A system of Market-Wide Circuit Breakers and Securities Level Price Bands has been put in place. - Principle 30. Systems for clearing and settlement of securities transactions should be subject to regulatory oversight, and designed to ensure that they are fair, effective and efficient and that they reduce systemic risk - Not assessed. *Annex Table 9. India: Summary Implementation of the IOSCO Objectives and Principles of Securities Regulation* ### Appendix Table 10. India: Recommended Action Plan to Improve ### Appendix Table 10. India: Recommended Action Plan to Improve Implementation of the IOSCO Principles ### Recommended actions by Principle - Principle 1 - 1) SEBI should continue to strengthen coordination by: - In the context of coordination with MCA: strengthening mechanisms for cooperation in the review of prospectuses and periodic reporting, including enforcement actions. - In the context of coordination with the RSEs: determining whether additional reporting from the RSEs in connection with listing obligations would be beneficial, including any enforcement action. - In the context of financial groups: determining whether regular exchange of inspections reports should take place, as well as whether there is a need to share on a periodic basis other type of information - 2) The differences in regulatory treatment of NBFCs vis-à-vis regulated entities or intermediaries should be eliminated. - Principle 2 - 1) SEBI’s Act should be amended to remove the provision on termination of services of Board members of SEBI without due cause as contained under section 5(2) of that Act. - 2) The central government should clarify that the authority to give directions to SEBI should not be construed as to give the MoF the authority to supersede SEBI’s decisions on individual cases, in either licensing, supervision, or enforcement - 3) The authorities should review whether participation of the MoF in the joint mechanism to decide on hybrid products could be a threat to independence. - 4) SEBI should explore whether more detailed provisions to protect Board members and staff should be put in place. - 5) SEBI might wish to explore whether mechanisms for non-binding consultation of fees and discussion of the budget with regulated entities would be beneficial. - Principle 3 - 1) SEBI should analyze whether current resources are sufficient, in particular in the area of supervision. - 2) SEBI should consider whether additional incentives could be put in place to make salaries more competitive at a senior level with the overall objective of bringing more staff with market experience at different levels of the organization, including at the Board level. - Principle 4 - SEBI might wish to explore the creation of an internal audit unit. - Principle 5 - SEBI should consider developing more comprehensive regulations on conflict of interest for its staff, in light of the fact that many regulatory decisions are delegated at levels of the organization different from Board members. - Principle 7 - SEBI should continue to strengthen arrangements to address the conflicts of interest of the “for profit” model of the RSEs vis-à-vis their self-regulatory functions, as discussed in the assessment. - Principle 9 - 1) SEBI’s Act should be amended to explicitly provide investors with a private right of action. - 2) The authorities might wish to consider amending SEBI’s Act to provide SEBI with the authority to access telephone records, subject to judicial approval. - Principle 10 - 1) SEBI should strengthen its current program for the supervision of securities intermediaries as discussed under this Principle. - 2) Enforcement of compliance with listing obligations by RSEs should also be strengthened. The committee on noncompliance with listing obligations is a step in such direction. - 3) Criminal enforcement needs to be stepped up. In such context, the authorities should explore whether a similar arrangement to that existent for CIS could be extended to other types of securities offenses. - Principle 11 - The authorities might wish to consider amending SEBI’s Act to make explicit the power of SEBI to share information with foreign counterparts. - Principle 14 - 1) Enforcement of compliance with listing obligations by RSEs should be strengthened. The committee on noncompliance with listing obligations is a step in such direction. - 2) SEBI along with the RSEs should review whether current arrangements to review material events should be strengthened. - Principle 15 - SEBI should reform the tender offer regulations in order to ensure that all investors get equal exit opportunity in terms of the percentage of their holding that they can tender. - Principle 16 - Coordination with MCA for purposes of ensuring compliance by issuers with accounting standards should be enhanced. The recently created coordination committee is a step in such direction. - In the long term the authorities should review whether all functions related to listed companies should be vested in SEBI. - 1) Qualified statements should not be permitted. - 2) Mechanisms to enforce compliance with auditing standards should be strengthened. The Quality Review Board is a step in such direction. The authorities should examine whether it could be considered independent. - 3) The framework for auditor’s independence should be expanded. SEBI informed that the Companies bill would address this gap. - 4) The authorities should finalize implementation of IFRS equivalent standards. - Principle 17 - 1) SEBI should continue the implementation of a risk-based supervisory program for mutual funds (and their asset management company) as detailed in this assessment. - 2) SEBI might wish to consider whether additional guidance in relation to the definition of CIS is needed. - Principle 20 - SEBI might wish to consider whether price vending activity should be regulated and therefore whether specific regulations should be prescribed on entities currently performing such services. - Principle 21 - 1) SEBI should strengthen its current program for the supervision of securities intermediaries as discussed under Principle 10. - 2) SEBI should consider directing the RSEs to conduct onsite visits in connection with the registration of new members (either during the registration process, or within a short period after the license is granted). SEBI should also review whether current resources allocated by the RSEs to inspection of broker-dealers are sufficient. - Principle 22 - 1) SEBI should consider moving to a risk-based capital system. - 2) In tandem, SEBI should review prudential requirements reporting for intermediaries different from brokers. - Principle 23 - 1) The requirement of an independent verification of internal controls and risk management on a periodic basis should be extended to merchant banks and underwriters. - 2) SEBI should incorporate more directly the review of internal controls and risk management as part of its inspections program. In addition, more comprehensive guidelines on internal controls and risk management would be beneficial, especially if SEBI moves to a risk-based capital. - 3) SEBI should continue to provide incentives for the reduction of the backlog by intermediaries in regard to investors’ grievances. - Principle 24 - 1) The RSEs along with SEBI should make operational and test current default procedures. - 2) SEBI should consider developing a plan to deal with the failure of entities other than brokers. - Principle 28 - Criminal enforcement of market manipulation and other unfair practices should be strengthened. ### Authorities’ response: key points and statistics - SEBI appreciation and scope - SEBI notes the IMF and World Bank assessment recognizes that the regulatory and supervisory regime for securities market is well developed and largely in compliance with international standards. - SEBI observes the assessor applied higher standards than which is given in IOSCO principles. - Intermediaries: counts as on December 2011 - brokers: 19,557 - sub-brokers: 78,228 - foreign institutional investors: 1,767 - merchant bankers: 199 - portfolio managers: 246 - custodians: 19 - depository participants: 823 - Enforcement and inspections - Onsite inspections of brokers are primarily a responsibility of the RSEs. RSEs have developed a risk based approach categorizing brokers into three categories based on criteria including trading volume, number of clients, funds settled and number of complaints. - Enforcement actions during 2010–2011: - total numbers of enforcement actions initiated: 958 - total number of enforcement actions disposed: 1,803 - Half-yearly internal audit reports by brokers as on March 31, 2011: - BSE: 979 - NSE: 1,212 - Mutual funds supervision - SEBI has a two-tier supervision system: trustees supervise day-to-day operations; SEBI issues comprehensive guidelines (SEBI (Mutual Fund) Regulations, 1996 and circulars). - Asset management companies minimum net worth: not less than rupees ten cores. - Inspections are risk-based, undertaken based on assets under management and number of complaints; discretionary inspections based on issues identified in prior reports or filings. - Auditing and accounting standards - Companies Act and Chartered Accountants Act provide a framework for objectivity and integrity of accounting and audit. - Government created Quality Review Board for reviewing auditors' quality; NFRA proposed in Companies Bill, 2011 (placed before Parliament on December 14, 2011) to oversee auditors (Clause 132 of the Bill) with powers to order investigation, levy penalty, and bar professionals from practice. - SEBI conducted peer review on audits of top 50 companies following Satyam scam in 2009. - A review of corporate governance compliance based on reports filed during January 2006 to March 2007 led to adjudication proceedings against five public sector undertakings and 15 private sector companies. - Exchange governance, surveillance and committees - NSE demutualised in November 1994; BSE demutualised in 2004. - Integrated Market Surveillance System established to generate alerts and assist SEBI in monitoring; used to detect aberrations, analyze them, identify cases for investigation, and share findings with stock exchanges. - Committee under Chairmanship of Dr. Bimal Jalan constituted on February 8, 2010; report submitted on November 23, 2010 and under consideration by SEBI. - Criminal enforcement and case statistics - India follows criminal justice standard of "innocent till proven guilty"; enforcement must prove guilt beyond reasonable doubt. - civil/criminal courts cases pending: 59 as on March 31, 2011. - Observations on risk and capital - Intermediaries operate mainly in fee-based, pass-through models where investors bear primary risk. - SEBI specified initial and continuing minimum net worth requirements for various intermediaries. - For proprietary trading or fund-based activity, margins (initial margins, extreme loss margins, and mark-to-market losses) or additional deposits are required depending on exposure or risk; stock exchanges monitor and manage risk. - SEBI specified a comprehensive risk management framework for stock exchanges including categorization of securities for margins based on liquidity and volatility, and adjustments of margins from liquid assets deposited by members. ### CPSS-IOSCO assessment (Securities Settlement Systems and CCPs) — methodology and scope - Assessment context and timing - The assessment is of securities and derivatives clearing and settlement systems in India based on the CPSS-IOSCO Recommendations for Securities Settlement Systems (RSSS) and Recommendations for Central Counterparties (RCCP). - This assessment was conducted as part of the FSAP in September 2011. - Information and stakeholders consulted - Information used: relevant laws, bylaws, regulations, rules and procedures governing the systems, and other material. - Extensive discussions held with: RBI, SEBI, Forward Market Commission (FMC), CCIL, NSE, BSE, USE, MCX, MCX-SX, NSCCL, ICCL, NSDL, CDSL, primary dealers, banks, broker-dealers, and clearing banks facilitating cash settlement. - A self-assessment was prepared by CCIL. The Indian self-assessment concluded in 2009 included payment and securities clearing and settlement systems. - Institutional and market structure (scope limitations) - Clearing and settlement systems organized around product sets: - (i) government securities, money market instruments, and foreign exchange instruments; - (ii) corporate securities and financial derivatives; - (iii) commodity derivatives. - This assessment limited to clearing and settlement systems for sets (i) and (ii). - Different legal frameworks, regulatory arrangements, and operators apply across sets; systems are of systemic importance given transaction volumes. - Given growth and volumes of the commodity derivatives market, a detailed self-assessment by the FMC and/or an independent assessment of the commodity derivatives clearing and settlement systems is recommended in the immediate future. *Source: _cr1308 - Appendix Table 10. India: Recommended Action Plan to Improve Implementation of the IOSCO Principles* ### 171. Government securities are cleared by the CCIL and settled in the books of the ### _cr1308 - 171. Government securities are cleared by the CCIL and settled in the books of the ### Main Findings - The risk management framework for the securities and derivatives clearing and settlement systems in India is prudent, the operational reliability is high and the regulation and oversight functions are effective. - The National Payments System in India has undergone a major reform over the last two decades, in particular the securities and derivatives clearing and settlement systems. - The RTGS system, implemented in 2004, has provided an effective system for settlement of large value transactions including for the cash leg of government securities transactions. - Securities market infrastructure is segmented by product type; this segmentation may raise concerns on the overall efficiency of the capital market. - The multiplicity of systems does not negatively influence the stability of the financial infrastructure; two CCPs and CSDs for the same products may enhance stability as backups. ### Clearing and Settlement Structure (descriptive) - Government securities are cleared by the CCIL and settled in the books of the PDO system of RBI. - Money market and foreign exchange instruments are also cleared by CCIL; cash settlement takes place in the RTGS system of the RBI. - CCIL guarantees the settlement of the transactions and acts as CCP. RBI is the regulator and overseer based on the Payment System and Settlement Act of 2007. - Corporate securities and financial derivatives are traded on the NSE, BSE, USE, MCX-SX, and 17 regional exchanges. - Corporate securities and derivatives on NSE are cleared by NSCCL. - Corporate securities and equity derivatives on BSE are cleared by BSE; mutual funds and corporate bonds on BSE are cleared by ICCL. - ICCL also clears currency derivatives traded on USE. - MCX-SX trading platform transactions are cleared and settled by MCX-SX Clearing Corporation Limited (MCX-SX CCL). - NSCCL, BSE, ICCL, and MCX-SX CCL act as CCPs for corporate securities and derivatives. - Securities leg of transactions is settled in NSDL and CDSL; cash leg is settled in one of the commercial banks that act as clearing bank for the exchanges. - SEBI is the regulator and supervisor of these stock exchanges, including their clearing and settlement systems. ### Regulation, Oversight, and Inter-agency Coordination - Improvement needed by implementing formal arrangements for information sharing and policy coordination among regulators. - RBI (overseer of CCIL and PDO CSD) and SEBI (supervisor of corporate securities market) cooperate in various fora, but cooperation on payment and securities clearing and settlement systems is not formalized. - No explicit agreements are in place regarding information sharing or coordination of policy implementation. - Recommended topics for coordinated attention: - Improvements in liquidity risk management of CCPs. - An orchestrated approach to crisis management and default plans. - Settlement in central bank money. - Increasing the use of government securities as collateral to cover positions in corporate securities and derivatives. - RBI and SEBI are strongly encouraged to include the FMC in regular meetings. ### Crisis Management and Operational Resilience - Operational reliability is high and Business Continuity Planning and Disaster Recovery sites are in place. - Readiness to respond to a crisis would benefit from establishment and regular testing of detailed crisis management plans. - Crisis management plans should include: - Definition of a crisis management team. - Procedures to consult and inform participants and regulators. - Regular testing, e.g., simulating stress scenarios that affect financial and operational soundness. - Systems test connectivity to their back-up sites on a regular basis together with participants. ### Transparency - Transparency of all systems can be further improved. - The current and forthcoming relevant international disclosure framework should be published on the websites of different system operators. - The 2009 assessment results of the Committee on Financial Sector Assessment are available on the internet; these results are not updated and not all key questions are answered. ### Market Segmentation Concerns - Segregation between the government bond market and the corporate equity and derivative markets creates vertical silos and prevents stock brokers and retail clients who trade on stock exchanges from accessing the market for government bonds. - Retail investors are prevented from investing in government bonds and accessing a full range of available investment products. - Government bonds are not used by stock brokers and custodians to comply with margin requirements of CCPs. - Despite segmentation, multiplicity of systems may enhance stability by providing backups. ### PDO System Assessment (against RSSS) — Key Improvement Areas - Systems are broadly in compliance with the recommendations, with two being not applicable. - Improvement opportunities: - Legal framework: Explicit statement that assets of a client may not be used to cover obligations toward a third party in case of participant insolvency. - Transparency: RBI website lacks dedicated information about the PDO system; Government Securities Regulation and PDO manual not in the public domain; 2009 self-assessment results available but should be updated and all key questions answered. - Protection of customer assets: No arrangements to enable a customer’s positions to be moved to a solvent custodian in case of insolvency of its own custodian; recommended implementation of such tools. ### NSDL and CDSL Assessment (against RSSS) — Key Improvement Areas - CSDs observe or broadly observe the recommendations, with three being not applicable. - Improvement opportunities: - Legal framework: Finality and netting for stock exchange transactions are currently addressed in bylaws; recommended that legal backing be strengthened at the level of law. - Governance: Constitution of user groups to give a voice to participants not included in committees or the Board. - Efficiency: SEBI may conduct periodic assessments to benchmark CSD performance against international peers and request CSDs to maintain fee schedules in an easily comparable format. - Wholesale corporate bond segment: Despite a DvP model 1 mechanism for OTC traded corporate bonds, payment and securities transfers require participant initiation; efficiency should be enhanced by automating the DvP process and eliminating manual interventions. - Communication standards: CSDs may consider providing participants an option to use ISO 15022 and migrating interfaces with clearing corporations to ISO 15022. ### CCIL Assessment (against RCCP) — Key Improvement Areas - CCP observes or broadly observes the recommendations, with two being not applicable. - Improvement opportunities: - Measurement of credit exposure: CCIL needs to calculate exposures in all segments on an intraday basis using up-to-date positions and prices; value available collateral on an intraday basis. - Financial resources: Liquidity risk management framework should be enforced to cope with immediate liquidity demands; CCIL is developing arrangements with RBI; comprehensive tests including full model and parameter validations should be performed at least annually. - Default funds and risk mitigation: Recommended establishment of default funds for all segments and development of other risk mitigating tools to enlarge CCIL’s guarantee function. - Custody and settlement bank risks: Reduce concentration risk in the foreign exchange segment by opening a U.S. dollar account in at least one more bank; selecting one more custodian; selecting one more settlement bank. - Monitoring of banks: Increase frequency and intensity of monitoring of the financial condition of custodians and settlement banks, including foreign settlement banks; install mechanisms to monitor financial condition of all banks to which CCIL has exposures on an ongoing basis. - Monitoring settlement flow concentration among settlement banks that provide cash settlement in Indian rupees. - Default procedures: No explicit arrangements for segregation and portability of client accounts in case of default of a clearing participant; recommended that provisions be included in the legal framework and CCIL default procedures. ### NSCCL, BSE, ICCL Assessment (against RCCP) — Key Improvement Areas - CCPs broadly observe the recommendations, with two being not applicable. - Improvement opportunities: - Legal risk: Improve legal backing for clearing and settlement by addressing finality and netting at the level of law. - Financial resources and stress testing: - Strengthen stress testing procedures and incorporate liquidity risk management in addition to credit risk. - Include liquidity aspects in periodic stress testing and ensure credit lines cannot be revoked. - Conduct stress tests more frequently; BSE/ICCL currently conducts stress tests only on a yearly basis. - Assessment of adequacy of resources in extreme situations should be conducted at least monthly. - Annual comprehensive tests should include full model and parameter validation and consideration of scenario choices. - Stress scenarios should include extreme circumstances during the last year, the most volatile periods of the cash and derivative markets during the last few years (preferably the last one or two decades), and appropriate theoretical scenarios. - Default procedures: Draft a detailed action plan to implement default procedures in a timely and flexible manner, including definition of crisis manager and crisis team, decision ranges, timelines, and reporting to stakeholders. - Operational reliability: Recommended recovery time objective be reduced from one day to two hours; SEBI is drafting detailed guidelines on these topics. - Money settlements: Consider replacement of commercial bank settlement model with central bank settlement model for the medium term. - Corporate securities are settled in commercial bank money, exposing markets to settlement bank risk. - In practice cash flows are concentrated in very few clearing banks despite more than a dozen selected by stock exchanges. - Failure of one or two dominant clearing banks could seriously affect market stability. - Settlement in the RTGS system of RBI for all securities and derivatives trades would mitigate settlement bank risk, reduce dependency of CCPs on clearing banks, and facilitate RBI's role as lender of last resort. - Such a model would require RBI to review and adapt rules, procedures, services, and staff requirements. - Governance: Establish independent risk committees consisting of internal and external experts reporting directly to the Board of the CCPs to advise on margin model, collateral, default procedures, and new product clearing. - Participation requirements: Exclude small trading members from membership of CCPs; recommend a tiered system in the cash market so that only the largest, most solid brokers are clearing participants. ### Recommended Actions (Annex highlights) - PDO System (selected): - RSSS 1 – Legal Framework: The protection of customers’ assets in the PDO from any third-party claims on the participant should be explicitly mentioned in the legal framework; Government Securities Regulations and PDO manual could be made available online. - RSSS 17 – Transparency: Responses to the CPSS-IOSCO disclosure framework need periodic updating, more detail, and RBI review; consider a dedicated RBI website section with legal framework, governance, and risk assessment results. - RSSS 18 – Regulation and Oversight: RBI should establish a framework for cooperation with SEBI and FMC to exchange information and coordinate policy implementation; one option is use of the FSDC structure. - NSDL and CDSL (selected): - RSSS 1 – Legal Framework: Topics related to finality, netting, and protection of funds held with custodians should be dealt with at the level of a law or an implementing regulation. - RSSS 18 – Regulation and Oversight: RBI should establish a framework for cooperation with SEBI and FMC to exchange information and coordinate on policy implementation; one option is use of the FSDC structure. *Source: _cr1308 - 171. Government securities are cleared by the CCIL and settled in the books of the* ### Annex Table 13. India: Recommended Actions to Improve RCCP ### Annex Table 13. India: Recommended Actions to Improve RCCP ### Implementation—CCIL - RCCP 3 – Measurement and Management of Credit Exposure - The CCIL needs to progress its plans to have an ability to measure its exposure intraday based on up-to-date prices and position in all the segments and also have the ability to manage these exposures. - RCCP 5 – Financial Resources - The liquidity risk management framework needs to be enhanced to enable the CCIL to withstand settlement default of at least the largest participant. The CCIL should perform comprehensive tests at least annually. - RCCP 7 – Custody and Investment Risks - The CCIL should reduce its concentration risk in the foreign exchange segment by opening a US dollar account in at least one other bank in and to select another custodian. - The CCIL should institute mechanisms to assess on an ongoing basis the financial soundness of all the banks with which it has exposures, in particular with the domestic and foreign settlement banks. - RCCP 9 - Money Settlements - The CCIL should monitor the concentration of settlement flows for INR settlement, and establish thresholds beyond which it would take measures to reduce the concentration. In the US dollar segment, the CCIL should diversify both for settlement and for custody services and credit lines. - RCCP 15 – Regulation and Oversight - RBI should establish a framework for cooperation with SEBI and FMC to exchange information and coordinate on policy implementation. One option is to use the FSDC structure to realize this cooperation, but other ways may be chosen as well. ### Implementation—NSCCL, BSE, and ICCL - RCCP 1 - Legal Risk - It is recommended that the legal backing of the clearing and settlement process be improved by addressing the issues of finality and netting at the level of law. In addition, the assessors support SEBI’s review of the legal and regulatory framework to streamline the different laws, bylaws, rules, and regulations, which may improve the clarity of the legal system. - RCCP 5 – Financial Resources - In order to comply with this recommendation, the stress testing procedures of the CCPs should be strengthened. It is recommended that: - The robustness of the CCPs be increased by improving the liquidity risk management in addition to the management of credit risk. The CCPs should include liquidity aspects in their periodic stress testing and also ensure that their credit lines cannot be revoked. - Stress tests should be conducted on a more frequent basis. BSE/ICCL conducts stress only on a yearly basis, whereas the assessment of the adequacy of resources in extreme situations should be conducted at least monthly. On a yearly basis comprehensive tests should be performed, which include full model and parameter validation and consideration of scenario choices. - The current stress scenarios should include not only the most extreme circumstances during the last year, but also the most volatile periods of the cash and derivative markets during the few years, preferably the last one or two decades. Stress scenarios should include some appropriate theoretical scenarios as well. - RCCP 6 – Default Procedures - In order to comply with this recommendation the CCPs should draft a detailed action plan, with the objective to be able to implement its default procedures in a timely and flexible manner. The action plan may contain the definition of a crisis manager and crisis team, the range of decisions such a crisis manager and crisis team may consider under what conditions and according to what timelines, and the reporting of information to different stakeholders, being regulators, clearing participants, the stock exchanges, CSDs, and clearing banks. This action plan needs to be reviewed every year. - RCCP 9 - Money Settlements - In order to comply with this recommendation the CCPs should take measures to reduce its dependence on few, large clearing banks that settle the majority of the cash flows. The CCPs should more actively monitor the financial condition of these banks and develop plans to cope with the failure of one or more of the banks. For the medium term it is recommended to replace the commercial bank settlement model with the central bank settlement model. This will significantly reduce the systemically important role of these banks as well as the settlement bank risk to which the market is exposed. Instead the central bank settlement model should be used, with cash settlement in the RTGS system of RBI for all securities and derivatives. - RCCP 15 – Regulation and Oversight - RBI should establish a framework for cooperation with SEBI and FMC to exchange information and coordinate on policy implementation. One option is to use the FSDC structure to realize this cooperation, but other ways may be chosen as well. ### Authorities’ Response (SEBI) - Paragraph 182–187: SEBI expresses appreciation for the IMF and World Bank assessment and notes the FSAP assessment occurred at an opportune time to showcase the architecture of the securities system and to highlight areas for improvement. - Paragraph 183–185: SEBI notes major improvements since the 2001 FSAP in regulatory framework, range of products, growth and reach of market, technology, investor participation, and recognizes the assessment’s acknowledgment of the comprehensive risk management framework prescribed by SEBI, including: - online real-time margining; - requirement for participants to deposit liquid collateral with the CCPs; - real-time disablement of trading facility of the participants on exhaustion of the collateral; - default management procedures including segment-wise settlement guarantee fund; - inter-linkages between depositories; - market-wide circuit filters and security specific price bands. - Paragraph 186: SEBI has taken note of the FSAP suggestion to “replace the commercial bank settlement model with the central bank settlement model.” Suitable market-wide consultation with stock exchanges/clearing corporations, stock brokers/trading members, clearing members and RBI will be undertaken in future to examine the issue. - Paragraph 187: SEBI provides clarifications and requests reassessment of some ratings: - SEBI notes it has recommended amendments to the Securities Laws to provide for finality of settlement obligations and netting and that new laws are in process to provide for formal recognition of clearing corporations. Meanwhile bylaws deem settlements final and irrevocable and support netting, with Supreme Court rulings upholding applicability—Vinay Bubna Vs. Bombay Stock Exchange, Supreme Court, 1999; and, Bombay Stock Exchange vs. Jaya I. Shah and another, Supreme court, 2004. Novation is supported by the Contract Act. - SEBI emphasizes its prescription to make available details of fees/charges of various services of depositories/depository participants on the website of depositories for over five years as on date. - SEBI contests the FSAP description of margining timing for NSCCL, BSE, and ICCL, clarifying that initial and extreme loss margins are adjusted upfront, post-trade, from the collateral deposited by the participants with the CCP, and mark-to-market losses are collected in cash on the same day or latest before trading starts on the next day. - SEBI argues the rating for observance of RCCP 5 by NSCCL, BSE, and ICCL does not adequately reflect their observance, noting: - recent tests indicate amounts assured by the credit lines and the cash margins are sufficient to ensure timely settlement; - irrevocable credit lines with the major clearing banks of the CCPs (BSE and NSCCL) have been established; BSE and NSCCL have informed that their credit lines are irrevocable in nature and this was informed to the FSAP team. - SEBI has initiated the process to strengthen the stress testing procedures of CCPs. - SEBI requests upgrading the rating for observance of RCCP 6 by NSCCL, BSE, and ICCL, noting: - The bylaws of NSCCL and BSE provide details on situations when a member may be declared as a defaulter, utilization of funds including margins and the settlement guarantee fund in the event of default, etc. - CCPs have further detailed the above guidelines through rules, regulations, and circulars. - It is observed that the aforementioned suggestion to upgrade the rating has not been considered. - Paragraph 188: SEBI has constituted a committee to review the extant risk management framework in the cash market segment and derivatives segment. The committee will review guidelines on risk management, settlement guarantee fund, segregation of client assets, exposure of CCPs to the few large clearing banks, etc., and will consider concerns, suggestions, and recommendations of the FSAP team. *Source: Annex Table 13 and Annex Table 14 and Authorities’ Response as provided in the content unit.* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr1308.pdf_