UnderstandingFinanceSectorin

India
Dr.Prashant S.Desai
AssistantProfessorinLaw,
NationalLawSchoolofIndiaUniversity,
Bangalore560072.

Modulecontents
Understandingthearchitectureoffinance
sectorinIndia
Briefbackgroundofregulationpertainingto
financesectorinIndia
Flaggingupoffewchallengesandgrey
areasoffinancesector
Contextualizingthefuturediscourse

Whatisfinancesector?
Interestinglythetermfinancesectoris
nottechnicallyorlegallydefined
Therearefewexplanations

OECDsexplanation
financialsectoristhesetofinstitutions,
instrumentsandtheregulatory
frameworkthatpermittransactionstobe
madebyincurringandsettlingdebts;
thatisbyextendingcredit

Anotherexplanation
thetermfinancialsystem,impliedasetof
complexandcloselyconnectedorinterlinked
institutions,agents,practices,markets,
transactions,claimsandliabilitiesinthe
economy.Thefinancialsystemisconcerned
aboutmoney,creditandfinance thethree
termsareintimatelyrelatedyetaresomewhat
differentfromeachother

Yetanotherexplanation
financialinstitutionsarebusiness
organizationsthatactasmobilizersand
depositoriesofsavingsandaspurveyors
ofcreditorfinance.Theyalsoprovide
variousfinancialservicestothe
community

Fewmoreobservations
Thefinancialinstitutionsdifferfromnon
financial(industrialandcommercial)business
organizationsinrespectoftheirdealings;
Whiletheformerdealinfinancialassetssuch
asdepositsloanssecuritiesandsoon
Thelatterdealinequipment,stocksofgoods,
realestateetc.,

Indianfinancesector

Bankinginstitutions
NonBankingFinanceCompanies
Investment/Merchantbanks
MutualFunds
InsuranceCompanies
FactoringandFactoringCompanies
VentureCapitalCompanies
HousingFinanceCompanies
PortfolioManagers
MicroFinanceCompanies

Bankinginstitutions
Theinstitutionsdoingbankingbusiness
Acceptanceofdepositsandextensionofcredit
facilities
Recognizedasbankingcompaniesbytherelevant
law(i.e.,eithertheirrespectivededicatedstatute
orTheBankingRegulationAct,1949)

RoughlytheIndianBankscanbeclassifiedas
Scheduledand
NonScheduledbanks

Nonbankingfinancecompanies
PopularlyknownasNBFCs
TheseareregulatedbyRBIandallowed
toraisedepositsfromthepublic
Theyofferfinancialservicessuchleasing,
hirepurchasing,vehiclefinancingetc.,

 NBFCisacompanyregisteredunderthe
CompaniesAct,1956,engagedinthebusiness
ofloansandadvances,acquisitionofshares,
stock,bond,hirepurchase,insurance
business,orchitbusiness:butdoesnot
includeanyinstitutionwhoseprincipal
businessisthatofagricultureactivity,
industrialactivity,sale/purchase/construction
ofimmovableproperty.

 AspertheRBIAct,a'nonbankingfinancial
company'isdefinedas:
(i)afinancialinstitutionwhichisacompany;
(ii)anonbankinginstitutionwhichisacompanyand
whichhasasitsprincipalbusinessthereceivingof
deposits,underanyschemeorarrangementorin
anyothermanner,orlendinginanymanner;
(iii)suchothernonbankinginstitutionorclassof
suchinstitutions,asthebankmay,withthe
previousapprovaloftheCentralGovernmentand
bynotificationintheOfficialGazette,specify.

 Forregulatorypurposes,NBFCshavebeen
classifiedinto3categories:
a) Thoseacceptingpublicdeposits,
b) Thosenotacceptingpublicdepositsbut
engagedinfinancialbusinessand
c) Coreinvestmentcompanieswith90%oftheir
totalassetsasinvestmentsinthesecurities
oftheirgroup/holding/subsidiary
companies.

 Dependinguponthenatureandtypeofservice
provided,theyarecategorizedinto:
Assetfinancecompanies
Housingfinancecompanies
Venturecapitalfunds
Merchantbankingorganizations
Creditratingagencies
Factoringandforfaitingorganizations
Housingfinancecompanies
Stockbrokeringfirms
Depositories

 Notwithstandingtheirdiversity,NBFCsarecharacterised
bytheirabilitytoprovidenichefinancialservicesinthe
Indianeconomy.Becauseoftheirrelativeorganisational
flexibilityleadingtoabetterresponsemechanism,they
areoftenabletoprovidetailormadeservicesrelatively
fasterthanbanksandfinancialinstitutions.Thisenables
themtobuildupaclientelethatrangesfromsmall
borrowerstoestablishcorporate.WhileNBFCshave
oftenbeenleadersinfinancialinnovations,whichare
capableofenhancingthefunctionalefficiencyofthe
financialsystem,instancesofunsustainability,oftenon
accountofhighratesofinterestontheirdepositsand
periodicbankruptcies,underscoretheneedfor
reinforcingtheirfinancialviability.
ReportontrendsonprogressofbankinginIndia200203

Investmentbanks
Catertothelongterminvestmentrequirements
ofthemarkets
Generallyparticipateinequitycapitalofthe
companyorextensionoflongtermcapital
Afinancialintermediarythatperformsavariety
ofservices.Thisincludesunderwriting,actingas
anintermediarybetweenanissuerofsecurities
andtheinvestingpublic,facilitatingmergers
andothercorporatereorganizations,andalso
actingasabrokerforinstitutionalclients.

Mutualfunds
Amutualfundisacompanythatpoolsmoney
frommanyinvestorsandinvestsinwell
diversifiedportfolioofsoundinvestment.
issuessecurities(units)totheinvestors(unit
holders)inaccordancewiththequantumof
moneyinvestedbythem.
profitsharedbytheinvestorsinproportionto
theirinvestments.

 setupintheformoftrustandhasasponsor,
trustee,assetmanagementcompanyand
custodian
advantagesintermsofconvenience,lowerrisk,
expertmanagementandreducedtransaction
cost.
Verycriticalintodaysfinancialservicesmarket
Thefundsareinvestedinvariousinstruments
andmanagedbytheAssetManagement
Companies,whichactasInvestmentManager
oftheMutualFund

 Theygivesmallinvestorsaccesstoprofessionally
managed,diversifiedportfoliosofequities,bonds
andothersecurities,whichwouldbequite
difficulttocreatewithasmallamountofcapital.
Eachshareholderparticipatesproportionallyin
thegainorlossofthefund.
MutualFundRegulations,1996ofSecurities
ExchangeBoardofIndia
MutualFundisalsoregisteredasTrustunderthe
IndianTrustAct,1882

MutualFundOperationFlowChart

Insurancecompanies
Commencedplayingadominantroleinthe
financialmarketsespeciallyafterprivatization
Competitionintheinsurancesectorhas
createdmanyattractiveinsuranceproductsof
differentnaturetoinvestorsataffordable
rates
RegulatedbyInsuranceRegulatorAuthorityof
India

FactoringCompanies
Involvesthesaleofreceivablesbyacompany
toafinancialintermediarywhowillundertake
theactivityofmaintenanceofaccounts,
collectionofdebtsandfinancingagainst
receivables
NotverymuchpickedupinIndiaasofnow
Insufficientcreditinformation,
Lackofdatatoevaluatethedebtorsand
Clearassessmentofrisksfactors
Absenceofclearstatutetosupporttheactivity

Venturecapital
Istheextensionofcapitalassistanceor
participationbyacompanyorhighnetworth
investortoassistastartupanduntested
project
Thisistoencourageupcomingentrepreneurs
totakeupnewbusinessinitiatives
VentureCapitalistsareregulatedbySEBI
undertheVentureCapitalRegulations

1.TheinstitutionssuchasIDBIplayedakeyroleas
VentureCapitalistsinthecountry.
2.However,withtheintroductionofCessofFive
Percentontechnologyimportpayments,inthe
budgetof198788,theGovernmentofIndia
createdapooloffundstoassisttheventure
capitalundertakings.
3.Todaythecountryhasventurecapitalfunds
ownedbythebanks,developmentFinance
CompaniesandPrivateSectorcompaniesowned
byhighnetworthindividuals.
4.Todaythemajorityofthestartupprojectsare
financedbytheprivatesectorcompanies.

Housingfinancecompanies
Providefundingtotheconstructionor
purchaseofhousesbyindividuals,companies
etc.,
EstablishmentofHousing&Urban
DevelopmentCorporation(1970)
NationalHousingBank(assubsidiaryofRBI)
HousingDevelopmentFinanceCompany

 TheNationalHousingBankhasbeensetupasan
apexinstitutionundertheNationalHousingBank
Act,1987onJuly9,1988.
TheobjectiveoftheBankistooperateasa
principalagencytopromotehousingfinance
institutionsbothatlocalandregionallevelsand
toprovidefinancialandothersupporttosuch
institutions.
TheGoI hasadoptedacomprehensiveNational
HousingPolicywhichenvisagesdevelopmentofa
viableandaccessibleinstitutionalsystemforthe
provisionofhousingfinance.TheBankshaveset
upspecializedhousingfinanceinstitutions.

Portfoliomanagers
Financialservice(eitherbystockbrokeror
NBFC)toinvestonbehalfofinvestorsin
sharesandstocks
Especiallywhere investorsdonotdirectly
wanttoinvestbutareinterestedinhigh
returnsfromthestockmarkets
PortfolioManagementservicesareregulated
underSEBI(Portfolio)Management
Regulations

Microfinancecompanies
Microfinanceistheprovisionoffinancialservices
tolowincomeclientsorsolidaritylendinggroups
includingconsumersandtheselfemployed,who
traditionallylackaccesstobankingandrelated
services.
Provideselffinancialassistancetothepoor
womeninruralareasforthedevelopmentof
tinyorsmallindustrialgrowth

 InIndiaithasgrownmultifoldinrecentyears
Thesecompaniesavailcreditfacilitiesfrom
thebanktoextendtheseloanfacilities
Tillrecentlytherewasnoceilingofloanby
thesecompaniesnorthesecompanieswere
regulated.
However,itisproposedtobringaseparate
legislationtoregulatethesecompaniesand
alsoproposestocaptheceilingoflendingby
thesecompanies.

Theregulatoryenvironment

 PointsforDiscussion
PrinciplesrelatedtoRegulators
Whyregulatefinancesector?
Thefundamentalunderpinningofpolicies
a) Protectionofinvestors
b) Ensuringthatmarketsareclear,efficient&
transparent
c) Reductionofsystemicrisk
Thenewemergingchallenge

 Salientfeatures
Regulatoryprinciples
VariousRegulatoryBodies
FinancialSectorLegislativeReformsCommission
AnalysisofFinancialSectorReforms
a) ReformsinBankingSector
b) ReformsintheGovernmentSecuritiesMarket
c) ReformsintheForeignExchangeMarket

 Regulationreferstocontrollinghumanorsocietal
behaviorbyrulesorregulationsoralternativelya
ruleororderissuedbyanexecutiveauthorityor
regulatoryagencyofagovernmentandhaving
theforceoflaw.
Financialregulationdealswithdirectingthe
financialinstitutionslikebanks,insurance
companies,mortgageloancompanies,etc.to
fulfillcertainrequirements,imposingcertain
restrictionsandsettingoutguidelinessoasto
keepuptheintegrityoftheentirefinancial
system.

PrinciplesrelatedtoRegulators
Theregulatorsshouldhaveclearly&objectively
statedresponsibilities;
theyshouldhaveoperationalindependence&
accountabilityintheexerciseofitspowers&
functions;
theyshouldadoptclear&consistentregulatory
processes;
theyshouldobservethehighestprofessional
standardsincludingappropriatestandardsof
confidentiality.

Whyregulatefinancesector?
Obviousanswer
Thateveryhumanconducthastoberegulated
fromthesocietalpointofview

Specificanswer
Regulationtoencompassallactivities/institution
offinancesectorinordertoensureequityintheir
conduct,sothatendusersaregivenafairdeal
andanyunscrupulousplayersdealtwithfirmhand

Thefundamentalunderpinningof
policies
1. theeconomicstability
a.Reductionofsystemicrisks
b.Maintenanceofcustomerconfidence(byprevention
ofmarketabuseandfraudulentactivities)

2. Necessarysupportforoverallequitable
economicdevelopment
3. Investorinterestprotection
4. Ofcoursethebetterprotectionofthe
financialsectoroperatorsthemselves

Protectionofinvestors
Investorsarerequiredtobeprotectedfrombeing
misleadormanipulatedfromfraudulentpractices
includinginsidertradingandmisuseofclient
assets.
Itisthetaskoftheregulatortosetminimum
standardformarketparticipantsinorderto
achievealevelofinvestorprotection.
Themarketintermediariesshouldbeabletorefer
torulesofbusinessconductthatensurethat
investorswillbetreatedinajustandequitable
manner.

Ensuringthatmarketsareclear,
efficient&transparent
Itisthetaskoftheregulatortoensurethat
thereareregulationsfortheprotectionofthe
investorandtoensurefairnesswhileatthe
sametimeensuringthatthereisefficientand
transparentdisseminationofinformation.

Reductionofsystemicrisk
Noamountofregulationoroversightcan
guaranteeagainstthepossibilityoffinancial
failureofamarketintermediary.
However,regulationcanandshouldaimto
reducetheriskoffailure.Wheresuchfailure
doesoccur,itistheroleoftheregulatorto
seektoreducetheimpactofthatfailureand
toattempttoisolatetherisksolelytothe
failinginstitution.

Thenewemergingchallenge
Globalizingtrend(reductionof
geographicalboundaries)hasfurther
addedtothecomplexityofthe
regulationoffinancialsector

Salientfeatures
Thecountertrend(comparedtogenerictrend
ofliberalization)fromlessertomore
stringentregulation
Emergingglobalconsciousness
Broadsustentativelegislation:andplethora
ofsubordinatelegislation

Regulatoryprinciples
RULEBASED
REGULATION

Lessdiscretionary&regulatoris
guidedbytheletteroflaw

PRINCIPLE
BASED
REGULATION

Greaterlatitudetothemarket
players fostersacultureofmutual
trustandfaithintheregulator,

DISCRETION
BASED
REGULATION

Morediscretionwiththeregulator
makinghimmorepowerful

CENTRAL
GOVERNMENT

SEBI

IRDA

INSURANCE
COMPANIES

STOCK
EXCHANGE

MERCHANT
BANKERS

PORTFOLIO
MANGERS

MUTUALFUNDS

FACTORING

PAYMENT
SYSTEMS

BANKS

NBFCS

COOPERATIVE
BANKS

PRIMARY
DEALERS

RBI

FMC

COMMODITY
EXCHANGES

PENSION
REGULATORY
AUTHORITY
PENSION
FUNDS/
COMPANIES

VariousRegulatoryBodies
RBI itisthecentralbankingregulatorythat
governsthemonetarypolicyoftheIndianRupee.
TheRegulation&supervisionofbanksarekey
elementsofafinancialsafetynetasbanksare
oftenfoundatthecenterofsystemicfinancial
crisis.
TheReserveBankregulates&supervisesthe
majorpartofthefinancialsystem.The
supervisoryroleoftheReserveBankcovers
commercialbanks,urbancooperativebanks,
someFIs&NBFCs.

 SomeoftheFIs,inturn,regulatesand/orsupervise
otherinstitutionsinthefinancialsector,viz.,RRB&
centralandstatecooperativebanksaresupervised
byNABARD,andhousingfinancecompaniesby
NationalHousingBank(NHB).
Itsobjectivesaretomaintainpublicconfidencein
thesystem,protectdepositorsinterestandprovide
costeffectivebankingservicestothepublic.
TheBankingOmbudsmanSchemehasbeen
formulatedbytheRBIforeffectiveaddressingof
complaintsbybankcustomers.

 TheRBIcontrolsthemonetarysupply,monitors
economicindicatorslikethegrossdomestic
productandhastodecidethedesignofthe
rupeebanknotesaswellascoins.Inaccordance
withprovisionsoftheRBIAct,1934itsmain
functionsare:
i. Operatingmonetarypolicywiththeaimof
maintainingeconomicandfinancialstabilityand
ensuringadequatefinancialresourcesfor
developmentpurposes;
ii. Meetingthecurrencyrequirementofthe
public;
iii. Promotionofanefficientfinancialsystem;

iv. Foreignexchangereservemanagement;
v. Theconductofbankingandfinancial
operationsofthegovernment.
ToregulatetheissueofBankNotesand
keepingofreserveswithaviewtosecuring
monetarystabilityinIndiaandgenerallyto
operatethecurrencyandcreditsystemofthe
countrytoitsadvantage.

 SEBI itisastatutorybodythatgovernsthe
securitiesmarketofIndia withaviewof
protectingtheinterestofinvestors.
Thisbodylaysdownregulationsinorderto
ensureorderlygrowthandsmooth
functioningoftheIndianCapitalmarket.
TheoverallobjectivesofSEBIaretoprotect
theinterestofinvestorsandtopromotethe
developmentofstockexchangesandto
regulatetheactivitiesofstockmarket.

ProtectiveFunctionsofSEBI
ThisfunctionisperformedbySEBItoprotect
theinterestofinvestorandprovidesafetyof
investment.
SEBIcheckspricerigging,prohibitsinsider
trading,prohibitsfraudulentandunfairtrade
practicesinwhichitdoesnotallowthe
companiestomakemisleadingstatements
whicharelikelytoinducethesaleand
purchaseofsecuritiesbyanyotherperson.

DevelopmentalFunctionsofSEBI
ThesefunctionsareperformedbySEBIto
promoteanddevelopactivitiesinstock
exchangeandincreasethebusinessinstock
exchange.
SEBIpromotestrainingofintermediariesof
thesecuritiesmarket,triestopromote
activitiesofthestockexchangebyadopting
flexibleandadoptableapproach.

RegulatoryFunctionsofSEBI
Ithasframedrules&regulationsandacodeof
conducttoregulatetheintermediariessuchas
merchantbankers,brokers,underwriters,etc.
Itregistersandregulatestheworkingofstock
brokers,subbrokers,sharetransferagents,and
allthosewhoareassociatedwithstockexchange
inanymanner.
Itregistersandregulatestheworkingofmutual
fundsetc.
Itregulatestakeoverofcompanies.
Itconductsinquiriesandauditofstockexchanges

ForwardMarketsCommission(FMC)
Itisthechiefregulatorofforwardsandfuturesmarket
inIndia.
ItisastatutorybodysetupundertheForward
Contracts(Regulation)Act,1952
Itregulatesthecommodityderivativemarketsand
brokers.
Itprovidesregulatoryoversightinordertoensure
financialintegrity(i.e.topreventsystemicriskof
defaultbyonemajoroperatororgroupofoperators),
marketintegrity(i.e.toensurethatfuturepricesare
trulyalignedwiththeprospectivedemandandsupply
conditions)andtoprotect&promoteinterestsof
consumers/nonmembers.

 Theforwardmarketcommissionperformsthe
roleofamarketregulator.Afterassessingthe
marketsituationandtakingintoaccountthe
recommendationsmadebytheBoardof
DirectorsoftheCommodityExchange,the
Commissionapprovestherulesand
regulationsoftheExchangeinaccordance
withwhichtradingistobeconducted.

InsuranceRegulatoryandDevelopment
Authority
Itisanautonomousapexstatutorybodywhich
regulatesanddevelopstheinsuranceindustryinIndia.
Itisresponsibletoprotecttherightsofpolicyholders.
Itsroleandresponsibilitiesinvolvesproviding
certificateofregistrationtoalifeinsurancecompany,
toframeregulationsonprotectionofpolicyholders
interests,specifyingtherequisitequalifications,code
ofconductandpracticaltrainingforintermediariesor
insuranceintermediariesandagents.
Italsoaimstopromoteandregulateactivitiesof
professionalorganizationsconnectedwithlife
insurance,toadjudicatedisputesbetweeninsurersand
intermediariesorinsuranceintermediariesetc.

PensionfundRegulatoryandDevelopment
Authority
PFRDA itisanagencywhichpromotesoldage
incomesecuritybyregulatinganddeveloping
pensionfunds.
TheNationalPensionSystemTrustiscomposed
ofmembersrepresentingdiversefieldsand
bringswiderangeoftalenttotheregulatory
framework.
Italsointendstointensifyitsefforttowards
financialeducationandawarenessasapartofits
strategytoprotecttheinterestofthesubscribers.

 MinistryofFinance itisconcernedwith
taxation,unionbudgets,capitalmarketsand
financesfortheCentreandState.
HighLevelCoordinationCommittee it
maintainscoordinationbetweenthe
regulators.

FinancialSectorLegislativeReforms
Commission
TheUnionMinistryofFinanceconstitutedtheFSLRCin
March2011,withamandatetoreviewandsuggest
changestoexistinglaws&regulatoryinstitutionsinthe
financialsectortobringthemuptospeedwithglobally
prevalentstandards.
Twoyearslater,areportwasreleasedwhichadvocated
acomprehensiveoverhauloftheexistingregulatory
framework,includingthereplacementofasubstantial
bodyofexistinglawswiththeIndianFinancialCode
draftedbyFSLRC.
FSLRChasitsresponsibilityofreviewing,simplifying
andmodernizingthelegislationsaffectingthefinancial
markets.

 FSLRChasendorsedatransitiontoamore
scientificregulatoryarchitecturerecommended
bygovernmentreportssuchasRaghuram Rajan
CommitteereportandPercyMistry Committee
report.
Thelessonlearntfromtheglobaleconomic
downturnpressedFSLRCtoproposeanew
regulatoryframework.
ThethreeelementsinFSLRCapproachare:
1. Modesofindependence
2. Accountability
3. Rulemakingprocessofregulators.

 Theregulatoryobjectivesshouldbeclearlydefined.
Theregulatorshouldbeempoweredwithrespective
instrumentsthatdonotpreventinnovation.
Attimestheregulatormighthavetochoosebetween
innovationandreducingrisk,buteliminatingrisk
altogetherisnotagoodoptionasitwillrestrictfinance
fromreachingouttonewcustomers,productsand
markets,thusrestrictingthepoweroftheregulator.
WithavisiontoprotectpublicinterestFSLRC
emphasizesongovernanceofregulation.Regulators
willbeindependentbutshouldbeaccountable.It
discouragestheideaofbringingtoomanyinnovations
inthefinancialsystemandechoestokeepitsimplebut
powerful.

 TheFSLRChassuggestedthecreationofthe
UnifiedFinancialAgency(UFA),anewbodywhich
wouldbeentrustedwithmicroprudential
regulationandconsumerprotectionforall
financialsectorsotherthanbankingandpayment
systems.
Thisbodywouldsubsumetheexistingregulators
forcapitalmarkets(SEBI),forwardmarkets
(ForwardMarketCommission),insurance(IRDA)
andpension(PensionFundRegulatoryand
DevelopmentAuthority).

 RBIwouldcontinueinthenewsetupasthe
regulatorforbankingandpaymentsystems
andframemonetarypolicy.
RBIwouldalsoberesponsibleforcapital
outflowsfromthecountry,achangefromthe
presentmodelwheretheRBImakesrulesfor
capitalaccounttransactionsinconsultation
withthegovernmentandviceversafor
currentaccounttransactions.

 TheFSLRCalsoenvisagesthecreationofthe
PublicDebtManagementAgency(PDMA),an
independentbodywhichwilltakeoverthetaskof
handlinggovernmentalmarketborrowingsfrom
theRBI,andwilladditionallymanagethecash
andcontingentliabilitiesofthegovernment.
TheFinancialStabilityandDevelopmentCouncil,
whichcurrentlycomprisesvarioussectoral
regulatorsandofficialsoftheMinistryofFinance,
willbegrantedthestatusofastatutorybody&
willberesponsibleformanagingsystemicrisks
andcoordinatingbetweendifferentregulatory
agencies.

 TheFSLRChassuggestedthecreationofa
ResolutionCorporationinplaceoftheDeposit
InsuranceandCreditGuaranteeCorporation
toassistinthespeedyresolutionandclosure
ofallsystematicallyimportantfinancial
institutionsorthosehavingstronglinkagesto
consumerssuchasbanks,insurance
companiesorpensionfunds.

 FinancialRedressalAgency(FRA)wouldbe
operatingasaconsumergrievanceredressal
mechanismacrossthefinancialsector.
AppealsfromtheFRAanddecisionsinrespectof
certainfunctionsoftheUFA,theRBIandthe
ResolutionCorporation,willbeheardbythe
FinancialSectorAppellateTribunal(FSAT),within
whichtheSecuritiesAppellateTribunalwillbe
subsumed.
Additionally,theFSATwillbeempoweredto
reviewregulationsongroundslikeprocedural
defects,theregulatorexceedingitsmandate,or
theregulationsbeinginviolationoftheCode.

AnalysisofFinancialSectorReforms
Removefinancialrepressionthatexisted
earlier;
Createanefficient,productiveandprofitable
financialsectorindustry;
Enablepricediscovery,particularly,bythe
marketdeterminationofinterestratesthat
thenhelpsefficientallocationofresources;
Provideoperationalandfunctionalautonomy
toinstitutions;

 Preparethefinancialsystemforincreasing
internationalcompetition;
Opentheexternalsectorinacalibratedfashion;
Promotethemaintenanceoffinancialstability
eveninthefaceofdomesticandexternalshocks.
Themainaimofthereformsintheearlyphaseof
reforms,knownasfirstgenerationofreforms,
wastocreateanefficient,productiveand
profitablefinancialserviceindustryoperating
withintheenvironmentofoperatingflexibility
andfunctionalautonomy.

Panchasutra orfiveprinciples
Cautiousandappropriatesequencingof
reformmeasures.
Introductionofnormsthataremutually
reinforcing.
Introductionofcomplementaryreformsacross
sectors.
Developmentoffinancialinstitutions.
Developmentoffinancialmarkets.

ReformsinBankingSector
PrudentialMeasures
1) Introduction&phasedimplementationof
internationalbestpracticesandnormsonrisk
weightedcapitaladequacyrequirement,accounting,
incomerecognition,provisioningandexposure.
2) Measurestostrengthenriskmanagementthrough
recognitionofdifferentcomponentsofrisk,
assignmentofriskweightstovariousassetclasses,
normsonconnectedlending,riskconcentration,
applicationofmarkettomarketprinciplefor
investmentportfolio&limitsondeploymentoffund
insensitiveactivities.

 CompetitionEnhancingMeasures
1) Grantingofoperationalautonomytopublic
sectorbanks,reductionofpublicownershipin
publicsectorbanksbyallowingthemtoraise
capitalfromequitymarketupto49%ofpaidup
capital.
2) TransparentnormsforentryofIndianPrivate
sector,foreign&jointventurebanks&
insurancecompanies,permissionforforeign
investmentinthefinancialsectorintheformof
FDIaswellasportfolioinvestment,permission
tobankstodiversifyproductportfolio&
businessactivities.

 MeasuresEnhancingRoleofMarketForces
1) Sharpreductionofpreemptionthroughreserve
requirement,marketdeterminedpricingfor
governmentsecurities,disbandingof
administeredinterestrateswithafew
exceptions&enhancedtransparency&
disclosurenormstofacilitatemarketdiscipline.
2) Introductionofpureinterbankcallmoney
market,auctionbasedreposreversereposfor
shorttermliquiditymanagement,facilitationof
improvedpaymentsandsettlementmechanism.

 Institutional&Legalmeasures
1) SettingupofLok Adalats,DRTs,ARCs,Settlement
advisorycommittees,corporatedebtrestructuring
mechanism,etc.forquickerrecovery/restructuring.
PromulgationofSARFAESIAct&itssubsequent
amendmenttoensurecreditorrights.
2) SettingupofCreditInformationBureaufor
informationsharingondefaultersasalsoother
borrowers.
3) SettingupofClearingCorporationofIndiaLtd.(CCIL)
toactascentralcounterpartyforfacilitating
payments&settlementsystemrelatingtofixed
incomesecurities&moneymarketinstruments.

 SupervisoryMeasures
1) EstablishmentoftheBoardforFinancial
Supervisionastheapexsupervisoryauthority
forcommercialbanks,financialinstitutionsand
NBFCs.
2) IntroductionofCAMELS(CapitalAdequacy,
Assets,ManagementCapability,Earnings,
Liquidity,Sensitivity)supervisoryratingsystem,
movetowardsriskbasedsupervision,
consolidatedsupervisionoffinancial
conglomerates,strengtheningofoffsite
surveillancethroughcontrolreturns.
3) Recastingoftheroleofstatutoryauditors,
increasedinternalcontrolthroughstrengthening
ofinternalaudit.

 Strengtheningcorporategovernance,enhanced
duediligenceonimportantshareholders,fitand
propertestsfordirectors.
TechnologyRelatedMeasures
SettingupofINFINETasthecommunication
backboneforthefinancialsector,introductionof
NegotiatedDealingSystem(NDS)forscreen
basedtradingingovernmentsecuritiesandReal
TimeSettlement(RTGS)System.

ReformsintheGovernmentSecurities
Market
InstitutionalMeasures
Administeredinterestratesongovt.securities
werereplacedbyanauctionsystemforprice
discovery.
Automaticmonetizationoffiscaldeficittrough
theissueofadhocTreasuryBillswasphased
out.
PrimaryDealerswereintroducedasmarket
makersinthegovernmentsecuritiesmarket.

 Forensuringtransparencyinthetradingofgovt.
securities,DeliveryversusPaymentsettlementsystem
wasintroduced.
Repurchaseagreement(repo)wasintroducedasatool
ofshorttermliquidityadjustment.Subsequently,the
LiquidityAdjustmentFacility(LAF)wasintroduced.LAF
operatesthroughrepoandreverserepoauctionstoset
upacorridorforshortterminterestrate.LAFhas
emergedasthetoolforbothliquiditymanagement
andalsosignalingdeviceforinterestratesinthe
overnightmarket.
MarketStabilizationScheme(MSS)hasbeen
introduced,whichhasexpandedtheinstruments
availabletotheReserveBankformanagingthesurplus
liquidityinthesystem.

 EnablingMeasures
ForeignInstitutionalInvestors(FIIs)wereallowedto
investingovernmentsecuritiessubjecttocertain
limits.
Introductionofautomatedscreenbasedtradingin
governmentsecuritiesthroughNegotiatedDealing
System(NDS).Settingupofriskfreepaymentsand
settlementsystemingovt.securitiesthroughClearing
CorporationofIndiaLtd(CCIL).Phasedintroductionof
RealTimeGrossSettlementSystem(RTGS).
Introductionoftradingofgovernmentsecuritieson
stockexchangesforpromotingretailinginsuch
securities,permittingnonbankstoparticipateinrepo
market.

ReformsintheForeignExchange
Market
ExchangeRateRegime
Evolutionofexchangerateregimefromasingle
currencyfixedexchangeratesystemtofixingthevalue
ofrupeeagainstabasketofcurrencies&furtherto
marketdeterminedfloatingexchangerateregime.
Adoptionofconvertibilityofrupeeforcurrentaccount
transactionswithacceptanceofArticleVIIIofthe
ArticlesofAgreementoftheIMF.Defactofullcapital
accountconvertibilityfornonresidentsandcalibrated
liberalizationoftransactionsundertakenforcapital
accountpurposesinthecaseofresidents.

 InstitutionalFramework
ReplacementoftheearlierFERA,1973bythe
marketfriendlyFEMA,1999.delegationof
considerablepowersbyRBItoAuthorized
Dealerstoreleaseforeignexchangefora
varietyofpurposes.

 IncreaseinInstrumentsintheForeignExchange
Market
Developmentofrupeeforeigncurrencyswap
market.
Introductionofadditionalhedginginstruments,
suchas,foreigncurrencyrupeeoptions.
Authorizeddealerspermittedtouseinnovative
productslikecrosscurrencyoptions,interestrate
andcurrencyswaps,caps/collarsandforward
rateagreements(FRAs)intheinternationalforex
market.

 LiberalizationMeasures
Authorizeddealerspermittedtoinitiatetrading
positions,borrowandinvestinoverseasmarket
subjecttocertainspecificationsandratification
byrespectiveBanksBoards.Banksarealso
permittedtofixinterestratesonnonresident
deposits,subjecttocertainspecifications,use
derivativeproductsforassetliability
managementandfixovernightopenposition
limitsandgaplimitsintheforeignexchange
market,subjecttoratificationbyRBI.

 Permissiontovariousparticipantsintheforeign
exchangemarket,includingexporters,Indians
investingabroad,ForeignInstitutionalInvestors
(FIIs),toavailforwardcoverandenterintoswap
transactionswithoutanylimitsubjecttogenuine
underlyingexposure.
FIIsandNRIspermittedtotradeinexchange
tradedderivativecontractssubjecttocertain
conditions.
Foreignexchangeearnerspermittedtomaintain
foreigncurrencyaccounts.Residentsare
permittedtoopensuchaccountswithinthe
generallimitofUS$25,000peryear.