c








c


á Ê Presentation Economic Environment of Business The Financial Sector Reforms Slow but steady «not to forget the socio
economic needs « á The financial Sector Reforms September 9, 2009

2 Ê
ROUP ‡ AJAY K DHAMIJA N-á ‡ SNEHAL SONI N-47 2 The financial Sector Reforms September 9, 2009

3 Ê overage ‡Introduction ‡Major ontours of Reforms ‡Banking sector Reforms ‡Monitory Policy Reforms ‡Financial Markets
Reforms ‡Forex Market Reforms ‡Assesment ‡onclusions 3 The financial Sector Reforms September 9, 2009

4 Ê Introduction ‡ FIVE Principle ± Measured, gradual, cautious and steady sequencing of reforms ± Introduction of mutually
reinforcing norms ± Development of an Efficient, ompetitive and Stable financial sector ± Development of Financial
Institutions ± Introduction of complementary reforms across Monetary, Fiscal and external sector ‡ Broad based reforms touching
every sector ± Financial Sector ± Monetary and Fiscal Policy ± apital Market ± Foreign Exchange Market ± Money and

overnment Securities Market 4 The financial Sector Reforms September 9, 2009

5 Ê In early á990s Lion in jungle ‡ Financial Repression vs lion in cage ± Extensive Regulations ± Administered Interest rates ±
Directed redit Programmes ± Weak Banking Structure ± Lack of Proper Accounting & Risk management systems ± Lack of
transparency in operations 5 The financial Sector Reforms September 9, 2009

6 Ê In early á990s« ± Pre-emption of resources from the banking system by the Pre- government to finance its fiscal deficit ±
Excessive structural and micro regulation that inhibited financial innovation and increased transaction costs ± Relatively
inadequate level of prudential regulation in the financial sector ± Poorly developed debt and money markets ± Outdated (often
primitive) technological and institutional structures that made the capital markets and the rest of the financial system highly
inefficient 6 The financial Sector Reforms September 9, 2009

7 Ê Resulting into « ‡
overnment regulated the price at which firms could issue equity, the rate of interest which they could offer
on their bonds, and the debt equity ratio that was permissible in different Industries ‡ Working capital management was even
more constrained with detailed regulations on how much inventory the firms could carry or how much credit they could give to
their customers ‡ Working capital was financed almost entirely by banks at interest rates laid down by the central bank ‡
Working capital finance was related more to the credit need of the borrower than to creditworthiness 7 The financial Sector
Reforms September 9, 2009

8 Ê « and « ‡ Volatility was not something that most finance managers worried about or needed to ± The exchange rate of the
rupee changed predictably and almost imperceptibly ± Administered interest rates were changed infrequently and the changes too
were usually quite small ‡ Financial genius consisted largely of finding one¶s way through the regulatory maze, exploiting
loopholes wherever they existed and above all cultivating relationships with those officials in the banks and institutions who had
some discretionary powers ‡ Even an overnight cash surplus could be parked in the overdraft account where it could earn (or
rather save) interest at the firm¶s borrowing rate 8 The financial Sector Reforms September 9, 2009

9 Ê At larger level « ‡ The balance of payments crisis that threatened the international credibility of the country and pushed it to the
brink of default ‡ The grave threat of insolvency confronting the banking system which had for years concealed its problems with
the help of defective accounting policies ‡ Hindered efficient allocation of resources 9 The financial Sector Reforms September
9, 2009

á0 Ê Major ontours of Reforms ‡ Removal of existing financial repression ‡ reation of an efficient, productive and profitable
financial sector ‡ Enabling the process of price discovery by the market determination of interest rates that improves allocative
efficiency of resources ‡ Providing operational and functional autonomy to institutions ‡ Preparing the financial system for
increasing international competition ‡ Opening the external sector in a a calibrated manner ‡ Promoting financial stability in the
wake of domestic and external shocks á0 The financial Sector Reforms September 9, 2009
áá Ê Two phased Reforms ‡ First
eneration (Early á990):- Ist Phase: á990):- ± reating an efficient, productive and profitable
financial sector to function with operational flexibility and functional autonomy ‡ Second
eneration (Mid á990 «) :- IInd phase
:- ± Strengthening the financial system and introducing structural improvements áá The financial Sector Reforms September 9,
2009

á2 Ê Major Sectors of Reforms ‡ Banking Sector ‡ Monetary Policy ‡ Financial Markets ‡ Forex Market á2 The financial Sector
Reforms September 9, 2009

á3 Ê Banking Sector Reforms ‡ ompetition Enhancing Measures ‡ Measures Enhancing Role of Market Forces ‡ Prudential Measures
‡ Institutional and Legal Measures ‡ Supervisory Measures ‡ Technology Related Measures á3 The financial Sector Reforms
September 9, 2009

á4 Ê Banking Sector Reforms : ompetition Enhancing Measures ‡ Operational autonomy to Public Sector banks ‡ Reduction in
public ownership of public sector banks ± an raise capital from equity market up to 49% of paid up capital ‡ Transparent Norms
related to entry, mergers /amalgamation and governance issues for Indian private sector, foreign and joint-venture joint- banks,
NBF¶s and insurance companies ‡ Permission for foreign investment in the financial sector in the form of Foreign Direct
Investment (FDI) as well as portfolio investment ‡ Permission to banks to diversify product portfolio and business activities á4
The financial Sector Reforms September 9, 2009

á5 Ê Banking Sector Reforms : Measures Enhancing Role of Market Forces ‡ Sharp reduction in pre-emption through reserve
requirement pre- ‡ Market determined pricing for government securities ‡ Disbanding of administered interest rates ‡ Enhanced
transparency and disclosure norms to facilitate market discipline ‡ Introduction of pure inter-bank call money market and
developing inter- markets for securitized assets ‡ Auction-based repos-reverse repos for short-term liquidity Auction- repos-
short- management and Improved payments and settlement mechanism á5 The financial Sector Reforms September 9, 2009

á6 Ê Banking Sector Reforms : Prudential Measures ‡ Introduction and phased implementation of international best practices and
norms related to:- RAR, Income recognition, Provisioning and Exposure ‡ Strengthen risk management :- ± Assignment of risk-
weights to various asset classes ± Norms on connected lending, risk concentration ± Application of marked-to-market principle
for investment portfolio and limits on deployment of fund in sensitive activities ± 'Know Your ustomerµ norms ± 'Anti Money
Laundering' guidelines ±
raded provisioning for NPA¶s ± apital charge for market risk ‡
uidelines for ownership and
governance, securitization and debt restructuring mechanisms norms, etc á6 The financial Sector Reforms September 9, 2009

á7 Ê Banking Sector Reforms : Prudential Measures:- Roadmap for Basel II Measures:- ‡ Implementing Basel II with effect from
March 3á, 2007 ‡ Standardized Approach for credit risk and Basic Indicator Approach for operational risk (First Phase) ‡ Migrate
to the Internal Rating Based (IRB) Approach after adequate skills are developed (Second Phase) ‡ Basel II will require more
capital for banks in India ± Presently RAR is over á2 per cent ± New and Innovative Funding options Perpetual debt
instruments and non- non- cumulative preference shares Redeemable cumulative preference shares and hybrid debt instruments
á7 The financial Sector Reforms September 9, 2009

á8 Ê Banking Sector Reforms : Institutional and Legal Measures ‡ Setting up of Lok Adalats (people¶s courts), debt recovery tribunals,
asset reconstruction companies, settlement advisory committees, corporate debt restructuring mechanism, etc ‡ Promulgation of
Securitization and Reconstruction of Financial Assets and Enforcement of Securities Interest (SARFAESI) Act, 2002 and its
subsequent amendment to ensure creditor rights ‡ Setting up of redit Information Bureau of India Limited (IBIL) for
information sharing on defaulters as also other borrowers ‡ Setting up of learing orporation of India Limited (IL) to act as
central counter party for facilitating payments and settlement system relating to fixed income securities and money market
instruments á8 The financial Sector Reforms September 9, 2009

á9 Ê Banking Sector Reforms : Supervisory Measures ‡ Board for Financial Supervision as the apex supervisory authority for Risk
based supervision ‡ Introduction of AMELS supervisory rating system (i e , capital adequacy, asset quality, management,
earning, liquidity and system and control) ‡ onsolidated supervision of financial conglomerates ‡ Recasting of the role of
statutory auditors with increased internal control through strengthening of internal audit ‡ Strengthening corporate governance ‡
 Fit and proper tests for directors along-with enhanced due diligence on important shareholders á9 The financial Sector Reforms
September 9, 2009

20 Ê Banking Sector Reforms : Technology Related Measures ‡ INFINET as the communication backbone for the financial sector ‡
Negotiated Dealing System (NDS) for screen-based trading in government securities ‡ Real Time
ross Settlement (RT
S)
System True test of the success of the banking reforms would be the extent of NPA¶s 20 The financial Sector Reforms September
9, 2009

2á Ê Monitory Policy Reforms ‡ Objectives ‡ Instruments ‡ Developmental Measures ‡ Institutional Measures 2á The financial Sector
Reforms September 9, 2009

22 Ê Monitory Policy Reforms : Objectives ‡ Twin objectives of ³Maintaining price stability´ and ³Ensuring availability of adequate
credit to productive sectors ‡ Use of broad money (M2) as an intermediate target has been de- emphasized and a multiple
indicator approach has been adopted ‡ Development of multiple instruments to transmit liquidity and interest rate signals in the
short-term in a flexible and bi-directional manner ‡ Increase of the inter-linkage between various segments of the financial market
including money, government security and forex markets 22 The financial Sector Reforms September 9, 2009

23 Ê Monitory Policy Reforms : Instruments: Strategic Shift: From Direct to Indirect ‡ Open market operations (OMO) to deal with
overall market liquidity situation especially those emanating from capital flows ‡ Introduction of Market Stabilization Scheme
(MSS) as an additional instrument to deal with enduring capital inflows without affecting short-term liquidity management role
of LAF ‡ Introduction of Liquidity Adjustment Facility (LAF), which operates through repo and reverse repo auctions Liquidity
Adjustment Facility ( LAF ) ± To nudge overnight interest rates within a specified corridor ± TO de-emphasize targeting of bank
reserves and focus increasingly on interest rates ± reducing the cash reserve ratio (RR) without loss of monetary control 23
The financial Sector Reforms September 9, 2009

24 Ê LAF + OMO + MSS => Flexibility Transition from direct instruments of monetary control such as administered interest rate,
reserve requirement, selective capital control) to indirect instruments like open market operations, purchase and repurchase of
government securities ‡ Advantages ± ertain dead weight loss for the system was saved ±
reater flexibility in determining
both the quantum of adjustment as well as the rates by responding to the needs of the system on a daily basis ± Modulation of the
supply of funds on a daily basis to meet day- to-day liquidity mismatches ± demand for funds are affected through policy rate
changes ± Stabilization of short-term money market rates 24 The financial Sector Reforms September 9, 2009

25 Ê Monitory Policy Reforms : Developmental Measures ‡ Discontinuation of automatic monetization through an agreement between
the
overnment and the Reserve Bank ‡ Amendment of Securities ontracts Regulation Act (SRA), to create the regulatory
framework ‡ Introduction of automated screen-based trading in government securities through Negotiated Dealing System
(NDS) ‡ Setting up of risk-free payments and system in government securities through learing orporation of India Limited
(IL) ‡ Phased introduction of Real Time
ross Settlement (RT
S) System ‡ Deepening of inter-bank Repo market Deepening
of government securities market by making the interest rates on such securities market related 25 The financial Sector Reforms
September 9, 2009

26 Ê Monitory Policy Reforms : Institutional Measures ‡ Setting up of Technical Advisory ommittee on Monetary Policy with
outside experts to review macroeconomic and monetary developments and advise the Reserve Bank on the stance of monetary
policy ‡ reation of a separate Financial Market Department within the RBI ‡ Development of appropriate trading, payments and
settlement systems along with technological infrastructure Success of monetary management such as interest rates, is contingent
upon the extent and speed with which changes in the central bank's policy rate are transmitted to the spectrum of market interest
rates and exchange rate in the economy and onward to the real sector 26 The financial Sector Reforms September 9, 2009

27 Ê apital Market Reforms : ‡ Abolition of capital issues control and the introduction of free pricing of equity issues (I) ‡
Securities and Exchange Board of India (SEBI) was set up as the apex regulator of the Indian capital markets ‡ Primary market
regulations: ± Entry norms for capital issues were tightened ± Disclosure requirements were improved ± Regulations were framed
and code of conduct laid down for merchant bankers ± Underwriters, mutual funds, bankers to the issue and other intermediaries
 ‡ orporate governance regulations: ± Regulations were framed for insider trading ± Regulatory framework for take overs was
revamped 27 The financial Sector Reforms September 9, 2009

28 Ê apital Market Reforms ‡ Secondary market regulations: ± apital adequacy and prudential regulations were introduced for
brokers, and other intermediaries ± Dematerialization of scrips was initiated with the creation of a legislative framework and the
setting up of the first depository ± Settlement period was reduced to one week ± arry forward trading was banned ± Tentative
moves were made towards a rolling settlement system 28 The financial Sector Reforms September 9, 2009

29 Ê Reforms in
overnment Securities Market ‡ Institutional Measures ‡ Increase in Instruments in the
overnment Securities
Market ‡ Enabling Measures 29 The financial Sector Reforms September 9, 2009

30 Ê
overnment Securities Market : Institutional Measures ‡ Administered interest rates on government securities were replaced by
an auction system for price discovery ‡ Banks have been permitted to undertake primary dealer business while primary dealers
are being allowed to diversify their business ‡ entral
overnment would cease to raise resources on behalf of State

overnments State
overnments' capability in raising resources will be market determined and based on their own financial
health ‡ Effective April á, 2006, RBI has withdrawn from participating in primary market auctions of
overnment paper ± fully
market based system in the
-sec market 30 The financial Sector Reforms September 9, 2009

3á Ê
overnment Securities Market : Increase in Instruments ‡ Market Stabilization Scheme (MSS) has been introduced, which has
expanded the instruments available to the Reserve Bank for managing the enduring surplus liquidity in the system ± 9á-day
Treasury bill was introduced for benchmarking ± Zero oupon Bonds, Floating Rate Bonds, apital Indexed Bonds were issued
± Exchange traded interest rate futures were introduced ± OT interest rate derivatives like IRS/ FRAs were introduced ‡ Repo
status has been granted to State
overnment securities in order to improve secondary market 3á The financial Sector Reforms
September 9, 2009

32 Ê
overnment Securities Market : Enabling Measures ‡ Foreign Institutional Investors (FIIs) were allowed to invest in government
securities subject to certain limits with non-banks allowed to participate in repo market ‡ Introduction of automated screen-based
trading in government securities through Negotiated Dealing System (NDS) ‡ Setting up of risk-free payments and settlement
system in government securities through learing orporation of India Limited (IL) ‡ Phased introduction of Real Time
ross
Settlement System (RT
S) ‡ Introduction of trading in government securities on stock exchanges for promoting retailing and
Non-banks participation 32 The financial Sector Reforms September 9, 2009

33 Ê Reforms in Foreign Exchange Market ‡ Exchange Rate Regime ‡ Finance Mobilization ‡ Institutional Framework ‡ Increase in
Instruments in the Foreign Exchange Market ‡ Liberalization Measures 33 The financial Sector Reforms September 9, 2009

34 Ê Reforms in Foreign Exchange Market : Exchange Rate Regime ‡ Evolution of exchange rate regime from a single-currency fixed-
exchange rate system to fixing the value of rupee against a basket of currencies and further to market-determined floating
exchange rate regime ‡ Adoption of convertibility of rupee for current account transactions with acceptance of Article VIII of the
Articles of Agreement of the IMF ‡ De facto full capital account convertibility for non residents ‡ alibrated liberalization of
transactions undertaken for capital account purposes in the case of residents 34 The financial Sector Reforms September 9, 2009

35 Ê Reforms in Foreign Exchange Market : Finance Mobilization ‡ Indian companies were allowed to raise equity in international
markets subject to various restrictions ‡ Indian companies were allowed to borrow in international markets subject to a minimum
maturity, a ceiling on the maximum interest rate, and annual caps on aggregate external commercial borrowings by all entities put
together ‡ Indian mutual funds were allowed to invest a small portion of their assets abroad ‡ Indian companies were given
access to long dated forward contracts and to cross currency options 35 The financial Sector Reforms September 9, 2009

36 Ê Reforms in Foreign Exchange Market : Institutional Framework ‡ Replacement of the earlier Foreign Exchange Regulation Act
(FERA), á973 by the market friendly Foreign Exchange Management Act, á999 (FEMA) ‡ Delegation of considerable powers by
RBI to Authorized Dealers to release foreign exchange for a variety of purposes 36 The financial Sector Reforms September 9,
2009
37 Ê Reforms in Foreign Exchange Market : Increase in Instruments ‡ Development of rupee-foreign currency swap market ‡
Introduction of additional hedging instruments, such as, foreign currency-rupee options ‡ Permission to use innovative products
like cross-currency options, interest rate swaps (IRS) and currency swaps, caps/collars and forward rate agreements (FRAs) in the
international forex market 37 The financial Sector Reforms September 9, 2009

38 Ê Reforms in Foreign Exchange Market : Liberalization Measures ‡ Authorized dealers permitted to initiate trading positions,
borrow and invest in overseas market subject to certain specifications and ratification by respective Banks¶ Boards ‡ Banks are
also permitted to fix interest rates on non-resident deposits, subject to certain specifications ‡ Use of derivative products for asset-
liability management and fix overnight open position limits and gap limits in the foreign exchange market, subject to ratification
by RBI ‡ Permission to various participants in the foreign exchange market, including exporters, Indians investing abroad, FIIs,
to avail forward cover and enter into swap transactions without any limit subject to genuine underlying exposure 38 The financial
Sector Reforms September 9, 2009

39 Ê Reforms in Foreign Exchange Market : Liberalization Measures ‡ FII¶s and NRI¶s permitted to trade in exchange-traded
derivative contracts subject to certain conditions ‡ Foreign exchange earners permitted to maintain foreign currency accounts ‡
Residents are permitted to open such accounts within the general limit of US $ 200,000 per year 39 The financial Sector Reforms
September 9, 2009

40 Ê Financial Sector and Monetary Policy Reforms : An assessment Progress of ommercial Banking in India á969 á980 á99á á995
2000 2005 á 2 3 4 5 6 7 á ommercial Banks 73 á54 272 284 298 288 2 No of Bank Offices 8,262 34,594 60,570 64,234 67,868
68,339 Rural and semi -urban bank offices 5,á72 23,227 46,550 46,602 47,693 4749á 3 Population per Office (¶000s) 64 á6 á4
á5 á5 á6 4 Per capita Deposit (Rs ) 88 738 2,368 4,242 8,542 á6,699 5 Per capita redit (Rs ) 68 457 á,434 2,320 4,555 á0,á35 6
Priority Sector Advances@ (%) á5 37 39 34 35 40 7 Deposits (% of National Income) á6 36 48 48 54 65 40 The financial Sector
Reforms September 9, 2009

4á Ê Financial Sector and Monetary Policy Reforms : An Assessment Distribution of ommercial Banks According to Risk-weighted
apital Adequacy Year <4% 4-9 % 9-á0 % >á0 % Total á 2 3 4 5 6 á995-96 8 9 33 42 92 2000-0á 3 2 áá 84 á00 2004-05 á á 8
78 88 4á The financial Sector Reforms September 9, 2009

42 Ê Financial Sector and Monetary Policy Reforms : An Assessment Non-Performing Loans (NPL) of Scheduled ommercial
Banks(%)
ross NPL/
ross NPL/ Net NPL/ Net NPL/ advances Assets advances Assets á 2 3 4 5 á996-97 á5 7 7 8 á 3 3 á997-
98 á4 4 6 4 7 3 3 0 á998-99 á4 7 6 2 7 6 2 9 á999-00 á2 7 5 5 6 8 2 7 2000-0á áá 4 4 9 6 2 2 5 200á-02 á0 4 4 6 5 5 2 3 2002-03
8 8 4 4 4 á 9 2003-04 7 2 3 3 2 9 á 2 2004-05 5 2 2 6 2 0 9 42 The financial Sector Reforms September 9, 2009

43 Ê Financial Sector and Monetary Policy Reforms : An Assessment Select Productivity Indicators of Scheduled ommercial Banks
(Rs million at á993-94 prices) Year Business Profit per Business per employee Employee per branch á992 5 4 0 02 á09 9 á996
6 0 0 0á áá9 6 2000 9 7 0 05 á79 4 2005 á7 3 0 á3 267 0 43 The financial Sector Reforms September 9, 2009

44 Ê Financial Sector and Monetary Policy Reforms : An Assessment Despite record high international crude oil prices, inflation
remains low and inflation expectations also remain stable 44 The financial Sector Reforms September 9, 2009

45 Ê Financial Sector and Monetary Policy Reforms : An Assessment Fresh issuances under the MSS were suspended between
November 2005 and April 2006 due to tight liquidity Redemptions of securities/Treasury Bills issued earlier ± along with active
management of liquidity through repo/reverse repo operations under Liquidity Adjustment Facility - provided liquidity to the
market and imparted stability to financial markets With liquidity conditions improving, it was decided to again start issuing
securities under the MSS from May 2006 onwards 45 The financial Sector Reforms September 9, 2009

46 Ê Forex Reforms : An Assessment Exchange rate exhibiting reasonable two-way movement 46 The financial Sector Reforms
September 9, 2009
47 Ê Financial Sector and Monetary Policy Reforms : An Assessment redit Delivery increased from 30 per cent during á999-00 to 4á
per cent during 2004-05 and further to 48 per cent during 2005-06 47 The financial Sector Reforms September 9, 2009

48 Ê onclusion ‡ Financial system in India, through a measured, gradual, cautious, and steady process, has undergone substantial
transformation ‡ Reasonably sophisticated, diverse and resilient system through well-sequenced and coordinated policy measures
aimed at making the Indian financial sector more competitive, efficient, and stable ‡ Effective monetary management has enabled
price stability while ensuring availability of credit to support investment demand and growth in the economy 48 The financial
Sector Reforms September 9, 2009

49 Ê onclusion ‡ The multi-pronged approach towards managing capital account in conjunction with prudential and cautious
approach to financial liberalisation has ensured financial stability in contrast to the experience of many developing and emerging
economies ‡ Monetary policy and financial sector reforms in India had to be fine tuned to meet the challenges emanating from all
global and domestic shocks ‡ Viewed in this light, the success in maintaining price and financial stability is all the more
creditworthy ‡ The overall objective of maintaining price stability in the context of economic growth and financial stability will
remain 49 The financial Sector Reforms September 9, 2009

50 Ê Thank You 50 The financial Sector Reforms September 9, 2009