FINANCIAL INSTITUTIONS AND FINANCIAL MARKETS IN INDIA

Transcription

1 FINANCIAL INSTITUTIONS AND FINANCIAL MARKETS IN INDIA Functioning and Reforms Part I: India's Financial System: Evolution and Present Structure Part II: Financial Institutions: D Commercial Banks D Regional Rural Banks (RRBs) D Urban Co-operative Banks (UCBs) Rural Co-operative Credit Institutions Development Finance Institutions (DFIs) 0 Non-banking Financial Companies (NBFCs) D Mutual Funds Insurance Organisations Part III: Financial Markets: Money Market D Government Securities Market D Capital Market D Corporate Debt Market Foreign Exchange Market D Payment Systems, Clearing and Settlement Infrastructure D Integration of Financial Markets Part IV: Financial Instruments: Direct Financial Instruments Derivative Instruments Part V: Appendices Part VI: Glossary, Bibliography and Index By Niti Bhasin Assistant Professor, Department of Commerce, Delhi School of Economics, University of Delhi. New Century Publications New Delhi, India

2 CONTENTS IN BRIEF Part I: INDIA'S FINANCIAL SYSTEM: EVOLUTION AND PRESENT STRUCTURE 1. Financial System and Economic Development Post-Independence Developments in the Financial System Financial Inclusion Efforts in India Reserve Bank of India (RBI) and the Financial System PART II: FINANCIAL INSTITUTIONS IN INDIA Section A: Financial Institutions in India: An Introduction 5. Classification, Regulation and Supervision of Financial Institutions in India Section B: Commercial Banks in India 6. Commercial Banks in India: An Introduction Pre-Independence History of Commercial Banks Post-Independence Developments in Commercial Banking Credit Allocation Policies of Commercial Banks Prudential Regulatory Framework and Supervision of Commercial Banks Migration to Basel Norms by Commercial Banks Management of Non-performing Assets (NPAs) by Commercial Banks Customer Services by Commercial Banks Foreign Banks in India Summing up Section C: Regional Rural Banks (RRBs) and Co-operative Banks 16. Regional Rural Banks (RRBs) Urban Co-operative Banks (UCBs) Rural Co-operative Credit Institutions Section D: Other Financial Institutions 19. Development Finance Institutions (DFIs)

3 viii Financial Institutions and Financial Markets in India 20. Non-banking Financial Companies (NBFCs) Mutual Funds Insurance Organisations PART III; FINANCIAL MARKETS IN INDIA 23. Financial Markets: An Introduction Money Market Government Securities Market Capital Market Corporate Debt Market Foreign Exchange Market Payment Systems, Clearing and Settlement Infrastructure Integration of Financial Markets PART IV: FINANCIAL INSTRUMENTS 31. Principal Direct Financial Instruments of the Capital Market Derivative Instruments PART V: APPENDICES Appendix 1: Internet Banking: Techniques and Risk Management Appendix 2: Global Financial Crisis: Impact on India and Policy Response PART VI: GLOSSARY, BIBLIOGRAPHY AND INDEX Glossary of Money, Banking and Finance Bibliography Index

4 Contents in Detail About the Book Author's Profile... Contents in Briei. Contents in Detail Preface Abbreviations/Acronyms Key to Numeration v vi vii-viii ix-xxvi xxvii-1 li-lvi lvii-lviii Part I: INDIA'S FINANCIAL SYSTEM: EVOLUTION AND PRESENT STRUCTURE 1. Financial System and Economic Development Meaning and Importance of Financial System 1.2 Emerging Financial Paradigm From Financial Volatility to Financial Stability Role of the Government in Financial Development 1.3 Determinants of Access to Financial Services 1.4 Regulation and Supervision of Financial System 2. Post-Independence Developments in the Financial System State Domination of the Financial Sector ( ) Nationalisation of Imperial Bank of India (1955) Nationalisation of Life Insurance Business (1956) Nationalisation of Commercial Banks (1969 and 1980) Nationalisation of General Insurance Business (1973) 2.2 Rethinking on State Domination of Financial Sector 2.3 From Financial Repression to Financial Liberalisation (1991 onward) 2.4 India's Approach to Financial Sector Reforms Lessons from East'Asian Crisis 2.5 Strategy of Financial Sector Reforms Developing and Strengthening Financial Infrastructure Financial Regulation and Supervision Financial Openness 2.6 International Security Standards

5 x Financial Institutions and Financial Markets in India 2.7 Migration to Basel II Norms 2.8 Accounting and Auditing Standards Marking-to-market 2.9 Technological Solutions for Financial Services 2.10 Legal Reforms for Strengthening Financial Sector Recent Acts Enacted by the Parliament Bills Introduced in the Parliament Bills under Consideration of the Government 2.11 Committee on Financial Sector Reforms, Committee on Financial Sector Assessment (CFSA), Global Financial Crisis and India's Financial Sector 2.14 Achievements of Financial Sector Reforms and Areas of Concern 2.15 Summing Up 3. Financial Inclusion Efforts in India Financial Exclusion and Financial Inclusion Defined 3.2 Advantages of Financial Inclusion 3.3 Strategy for Building an Inclusive Financial Sector 3.4 Recent Measures for Financial Inclusion No Frills Account General Credit Card (GCC) Business Facilitator and Business Correspondent (BC) Models Passbook Facility Simplified KYC Procedure Credit Counselling and Financial Education 3.5 Recommendations of the Committee on Financial Inclusion 3.6 Conclusion 4. Reserve Bank of India (RBI) and the Financial System Changing Role of RBI in the Financial Sector 4.2 RBI's Consultative Process in Policy Formulation Web-based Communication Resource Management Discussions Standing Technical Advisory Committees 4.3 Financial Sector Technology Vision Document 4.4 Global Financial Crisis and the RBI

6 Contents xi PART II: FINANCIAL INSTITUTIONS IN INDIA Section A: Financial Institutions in India: An Introduction 5. Classification, Regulation and Supervision of Financial Institutions in India Classification of Financial Institutions in India 5.2 Regulation and Supervision of Financial Institutions in India Section B: Commercial Banks in India 6. Commercial Banks in India: An Introduction Meaning and Role of Commercial Banks 6.2 Functions of a Commercial Bank 6.3 Balance Sheet of a Commercial Bank Liabilities of a Bank Assets of a Bank 6.4 Legal Framework for Banking Sector in India Laws Related to Banking Operations Laws Relating to Debt Recovery and Enforcement of Security Laws Relating to Payment Systems Competition Act, 2002: Implications for the Banking Sector Other Laws Bills Awaiting Parliamentary Approval 6.5 Classification of Commercial Banks in India Scheduled and Non-scheduled Banks Indian and Foreign Banks Public Sector and Private Sector Banks 6.6 Ownership and Governance of Commercial Banks in India Public Sector Banks Private Sector Banks Foreign Banks in India 6.7 Deposit Insurance System 7. Pre-Independence History of Commercial Banks Presidency Banks 7.2 Paper Currency Act, Banking Crisis, 1913

7 xii Financial Institutions and Financial Markets in India 7.4 Reserve Bank of India Act, Indian Companies (Amendment) Act, Bank Failures and Remedial Measures 7.7 Regulation and Supervision 8. Post-Independence Developments in Commercial Banking Phase I: Early Years of Independence ( ) 8.2 Phase II: From Nationalisation of Banks till Initiation of Banking Sector Reforms ( ) 8.3 Phase III: Banking Sector Reforms since Backdrop of Banking Sector Reforms Objectives of Banking Sector Reforms Contents of Banking Sector Reforms 8.4 Challenges for Banking Sector 8.5 Summing Up 9. Credit Allocation Policies of Commercial Banks Credit Market Reforms 9.2 Flow of Credit to Agriculture and Allied Activities Advisory Committee on the Flow of Credit to Agriculture and Related Activities from the Banking System (Chairman: V.S. Vyas), Agricultural Debt Waiver and Debt Relief Scheme, Credit Flow to Micro, Small, and Medium Enterprises (MSMEs) Working Group on Flow of Credit to the Small and Medium Enterprises (SMEs), Group to Review,Guidelines on Credit Flow to SME Sector, Policy Package for Credit to Small and Medium Enterprises Working Group on Credit Delivery to the Micro and Small Enterprises Sector, Working Group to Review the Credit Guarantee Scheme of Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE), Credit to Export Sector Working Group to Review Export Credit, Expert Group on Credit-Deposit Ratio, 2005

8 Contents xiii 10. Prudential Regulatory Framework and Supervision of Commercial Banks Need for Regulation and Supervision 10.2 Regulatory and Supervisory Policy during the 1950s 10.3 Regulatory and Supervisory Policy during the 1960s 10.4 Nationalisation of Banks and Shift in Regulatory Focus (1970s) 10.5 Regulatory and Supervisory Policy during the 1980s 10.6 Post-liberalisation Period (1991 onwards) 10.7 On-site Supervision Working Group to Review the System of On-site Supervision over Banks, Off-site Monitoring and Surveillance 10.9 Modernisation of Banking Regulation and Supervision Risk Based Supervision (RBS) Supervision of Financial Conglomerates Working Group on Financial Conglomerates, Board for Financial Supervision Monitoring of Frauds Income Recognition, Asset Classification and Provisioning Provisions against Standard Assets Securitisation Guidelines Investment of Banks in Non-SLR Securities Valuation of Instruments/Assets Use of Credit Rating Agencies by Banks Payment of Dividends Mergers and Amalgamation of Banks Exposure Norms Investment Norms Capital Adequacy Norms Transparency and Disclosures Securitisation of Standard Assets Anti-money Laundering Guidelines Credit Information Bureau of India Ltd. (CIBIL) Outsourcing by Banks Compliance Function Consequences of Non-compliance Summing Up

9 xiv Financial Institutions and Financial Markets in India 11. Migration to Basel Norms by Commercial Banks Introduction 11.2 Basel I Norms Main Elements of Basel II Norms 11.3 Implementation of Basel Norms in India Migration to Advanced Approaches: Challenges 12. Management of Non-performing Assets (NPAs) by Commercial Banks : Securitisation, Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, Corporate Debt Restructuring 12.3 Debt Recovery Tribunals 12.4 Lok Adalats (Peoples Courts) 13. Customer Services by Commercial Banks Committee on Procedures and Performance Audit of Public Services (CPPAPS) 13.2 Collection and Processing of Cheques 13.3 Grievances Redressal Mechanism 13.4 Settlement of Claims of Deceased Depositors 13.5 Door-step Banking 13.6 Banking Codes and Standards Board of India 13.7 Remittance Facility to NRIs/PIOs 13.8 Shifting of Branches/Offices in Public Interest Service Branches/Regional Collection Centres 13.9 Technological Channels for the Delivery of Financial Services National Electronic Fund Transfer (NEFT) ATM Networks Credit Cards Satellite Banking 14. Foreign Banks in India Role of Foreign Banks 14.2 Advantages and Disadvantages of Foreign Banks 14.3 Road Map for Foreign Banks in India Phase I: March 2005 to March Phase II: April 2009 onward

10 Contents xv 15. Summing up Section C: Regional Rural Banks (RRBs) and Co-operative Banks 16. Regional Rural Banks (RRBs) Nature and Objectives of RRBs 16.2 Amalgamation of RRBS 16.3 Autonomy for RRBs 16.4 RRBs as Vehicles of Financial Inclusion 16.5 Factors Influencing the Performance of RRBs Area of Operation and Clientele Base Capital Base and Organisational Structure Loan Delinquencies Cost Structure and Poor Financial Management Skills Staff Structure Dependence on Sponsor Banks 16.6 Restructuring of RRBs 16.7 Manpower Challenges of RRBs 16.8 Computerisation in RRBs Working Group on Technology Upgradation of Regional Rural Banks, August Summing Up 17. Urban Co-operative Banks (UCBs) Importance of UCBs 17.2 Vision Document and Medium-Term Framework (MTF) for UCBs 17.3 Regulation and Supervision of UCBs: Strengthening Measures Memorandum of Understanding (MoU) with the State Governments Licensing of New Banks/Branches Income Recognition, Asset Classification and Provisioning Norms Exposure Norms Off-site Surveillance Know Your Customer (KYC) Guidelines Priority Sector Lending Disclosure Norms 17.4 Mergers/Amalgamations of UCBs 17.5 Relaxation of Investment Portfolios of UCBs

11 xvi Financial Institutions and Financial Markets in India 17.6 Restructuring of Scheduled UCBs with Negative Net Worth 17.7 Problem of Dual Control in Co-operative Banking Impairment in Governance and Management 17.8 Summing Up 18. Rural Co-operative Credit Institutions Classification of Rural Co-operatives Short-term Rural Co-operatives Long-term Rural Co-operatives 18.2 Importance of Rural Co-operatives 18.3 History of Rural Co-operatives 18.4 Primary Agricultural Credit Societies (PACS) 18.5 Regulatory Framework and Supervision Asset Classification for State Government Guaranteed Advances Additional Provisioning Requirement for NPAs Prudential Guidelines on Agricultural Advances Inspections 18.6 Problem of Triangular Regulation of Rural Co-operatives 18.7 Task Force on Revival of Rural Co-operative Credit Institutions, Self-help Group (SHG)-Bank Linkage Programme for Micro Credit Regional Spread Graduation of Mature SHGs into Micro-enterprises Microfinance and the Government Microfinance and the RBI 18.9 Kisan Credit Cards NABARD and the Co-operative Sector Resources of NABARD Rural Infrastructure Development Fund (RIDF) Credit Extended by NABARD Interest Rates charged by NABARD Summing up Section D: Other Financial Institutions 19. Development Finance Institutions (DFIs) Introduction 19.2 All-India Financial Institutions (AFFIs)

12 Contents xvii All-India Development Banks Specialised Financial Institutions investment Institutions Refinance Institutions 19.3 State Level Institutions State Financial Corporations (SFCs) State Industrial Development Corporations (SIDCs) 19.4 Working Group for Harmonising the Role and Operations of Development Finance Institutions and Banks, Development Finance Institutions (DFIs): The Changed Scenario 19.6 Regulation and Supervision of Financial Institutions 19.7 Recent Policy Initiatives Regarding DFIs 19.8 Summing Up 20. Non-banking Financial Companies (NBFCs) Classification of NBFCs 20.2 Importance of NBFCs 20.3 Regulation and Supervision of NBFCs Early History Bhabatosh Datta Study Group, James Raj Study Group, Chakravarty Committee, Narasimham Committee, Working Group on Financial Companies, Monitoring of NBFCs by Board for Financial Supervision (BFS) P.R. Khanna Committee, Reserve Bank of India (Amendment) Act, Task Force on Non-banking Finance Companies, Committee for Redesigning Balance Sheet Format for NBFCs, Supervisory Framework for NBFCs On-site Inspection Off-site Surveillance System External Auditing 20.8 Regulations over NBFCs Accepting Public Deposits Regulations over NBFCs not Accepting Public Deposits Regulations over Core Investment Companies

13 xviii Financial Institutions and Financial Markets in India 20.9 Residual Non-banking Companies (RNBCs) Mutual Benefit Financial Companies Expert Committee on Nidhis Miscellaneous Non-Banking Companies (MNBCs): Chit Fund Companies Guidelines for Mergers/Amalgamations NBFCs in Insurance Business Know Your Customer (KYC) Guidelines and Anti-Money Laundering Standards Summary of Policy Initiatives Regarding NBFCs in Recent Years Regulation and Supervision of NBFCs in Selected Countries France Singapore Australia Indonesia Hong Kong Malaysia Thailand Summing Up 21. Mutual Funds Legal and Regulatory Framework 21.2 History of Mutual Funds Bifurcation of UTI 21.3 Features of Mutual Fund Industry in India 21.4 Problems of Mutual Funds Competition with Government Schemes Competition from Insurance Volatility of Mutual Fund Performance Tax System Encourages Short-term Objectives 21.5 Mutual Funds and the Stock Market 21.6 Summing Up 22. Insurance Organisations Nationalisation of Insurance Business in India after Independence 22.2 Weaknesses of Insurance Industry Prior to Reforms of Late 1990s

14 Contents xix Low Productivity Lack of Information Technology Limited Availability of Insurance Products Poor Quality of Insurance Services 22.3 Committee on Reforms in Insurance Sector, Indian Insurance Business: From State Monopoly to Competition ^ 22.5 Regulations and Controls 22.6 Post-liberalisation Developments in Insurance Business Changes in the Nature and Structure of Products Broad-based Marketing of Insurance Products Rising Service Levels Increased Penetration in the Rural and Social Sectors Investment in Infrastructure and Social Sectors Health Insurance Micro Insurance Deposit Insurance System in India 22.7 FDI in the Insurance Sector 22.8 Summing Up PART III: FINANCIAL MARKETS IN INDIA 23. Financial Markets: An Introduction Importance of Financial Markets 23.2 Regulation and Supervision of Financial Markets in India 23.3 Financial Markets and Monetary Policy of the RBI 23.4 Financial Market Reforms in India 23.5 Summing Up 24. Money Market Meaning and Functions of Money Market 24.2 Reserve Bank of India (RBI) and the Money Market 24.3 Evolution of Money Market in India Pre-Independence Period Post-Independence Period 24.4 Developments in the Money Market since Components-wise Analysis of Money Market in India Call/Notice Money Market

15 xx Financial Institutions and Financial Markets in India Commercial Paper (CP) Certificates of Deposit (CDs) Repos Collateralised Borrowing and Lending Obligation (CBLO) 24.6 Report of the Technical Group on Money Market Follow-up Action 24.7 Areas of Concern 24.8 Summing Up 25. Government Securities Market Meaning of Securities and Government Securities 25.2 Importance of Government Securities Market 25.3 Government Securities Market: Legal Framework and Role of the RBI 25.4 Mandated Investments in Government Securities: Categories of Investors 25.5 Evolution of Government Securities Market Pre-reforms Period 25.6 Post-1991 Measures to Promote Government Securities Market 25.7 Fiscal Responsibility and Budget Management (FRBM) Act, Technical Group on Central Government Securities Market, Measures to Strengthen Primary Market Issuance Procedures Widening of Investor Base Gilt Funds Foreign Institutional Investors Retail Investors Measures to Strengthen Secondary Market Sale of Auctioned Stock Primary Dealer System Diversification of Instruments Transparency Technological Infrastructure for Government Securities Market Trading Infrastructure

16 Contents xxi Negotiated Dealing System (NDS) Clearing Corporation of India Ltd. (CCIL) Settlement Cycle When Issued (WI) Market Separation of Debt Management from Monetary Management Summing Up 26. Capital Market :..., Meaning and Importance of Capital market 26.2 Capital Market in the Pre-reforms (i.e. Pre-1991) Period 26.3 Establishment of Securities and Exchange Board of India (SEBI) 26.4 Capital Market Reforms since Modernisation of Stock Exchanges Stock Market Trading Infrastructure in Stock Exchanges Corporatisation and Demutualisation of Stock Exchanges 26.6 Depository System, Dematerialisation (Demat) and Rematerialisation Depository System Dematerialisation (Demat) Rematerialisation 26.7 Introduction of Free Pricing 26.8 Strengthening of Disclosure Norms 26.9 Transparency and Efficiency Shortening of Settlement Cycle Growth of Service Providers Protection of Investors Portfolio Investment Flows: Global and Indian Experiences Summing Up 27. Corporate Debt Market Significance of the Corporate Debt Market 27.2 Lessons from East Asian Crisis 27.3 Corporate Debt Market in India Emergence of Private Placement Market 27.4 Reasons for Slow Growth of Corporate Debt Market

17 xxii Financial Institutions and Financial Markets in India 27.5 High Level Expert Committee on Corporate Debt and Securitisation Corporate Debt Market: Securitised Debt Market 27.6 Development of Corporate Bond Market in Select Countries South Korea Malaysia Singapore Australia Thailand 27.7 Summing Up 28. Foreign Exchange Market Pre-Independence Period 28.2 Post-Independence Period Foreign Exchange Regulation Act (FERA), Par Value System of Exchange Rate ( ) Sterling Area Arrangement Single Currency Peg Basket Peg Foreign Exchange Regulation Act (FERA), Introduction of Intra-day Trading in Foreign Exchange Amendments to Reserve Bank of India Act, Foreign Exchange Crisis and Rethinking 28.3 Post-reforms Period (1991 onward) Downward Adjustment of Rupee Rate Introduction of Liberalised Exchange Rate Management System (LERMS) Introduction of Current Account Convertibility Expert Group on Foreign Exchange Markets Foreign Exchange Management Act (FEMA), Capital Account Convertibility (CAC) Technical Group on Foreign Exchange Market, Present Structure of Foreign Exchange Market Market Segments Market Players 28.5 Sources of Supply and Demand of Foreign Exchange Derivative Market Instruments 28.6 Foreign Exchange Exposure Norms of Commercial Banks

18 Contents xxiii Positions and Gaps Investments in Overseas Markets Overseas Foreign Currency Borrowings Gold Transactions Vostro Accounts 28.7 Foreign Exchange Reserves Motives for Holding Foreign Exchange Reserves High Level Committee on Balance of Payments, India's Foreign Exchange Reserves 28.8 Summing Up 29. Payment Systems, Clearing and Settlement Infrastructure Importance of a Sound Payment and Settlement System 29.2 Segments of Payment System 29.3 Large Value Payment Systems Real Time Gross Settlement (RTGS) System High Value Clearing 29.4 Retail Payment Systems Paper-based Systems (Cheques) Electronic Retail Payment Instruments Deficiencies in Retail Payment Systems 29.5 Reforms Pertaining to Clearing and Settlement 29.6 Central Counterparties Clearing Corporation of India Limited (CCIL) National Securities Clearing Corporation Ltd (NSCCL) 29.7 Government Securities Settlement System 29.8 Role of RBI in Payment and Settlement System Vision Document for Payment Systems, Board for Regulation and Supervision of Payment and Settlement Systems (BPSS) 29.9 Summing Up 30. Integration of Financial Markets Integration of Financial Markets: Conceptual Framework Meaning Heterogeneous Nature of Financial Markets Dimensions of Financial Market Integration Measures of Financial Integration Benefits and Risks of Financial Integration

19 xxiv Financial Institutions and Financial Markets in India 30.2 Need for Integration of Domestic Financial Markets 30.3 Measures Taken for Integration of Financial Markets in India Free Pricing Widening Participation New Instruments Institutional Measures Technology, Payment and Settlement Infrastructure 30.4 Segment-wise Integration Integration of the Government Securities Market Integration of the Credit Market Integration of the Foreign Exchange Market Stock Market Integration 30.5 Regional Financial Integration (Asia) SEANZA and SEACEN Asian Clearing Union (ACU) EMEAP SAARCFINANCE ASEAN Chiang Mai Initiative 30.6 International Financial Integration 30.7 Summing Up PART IV: FINANCIAL INSTRUMENTS 31. Principal Direct Financial Instruments of the Capital Market Ordinary Shares 31.2 Preference Shares 31.3 Debentures 32. Derivative Instruments Emergence of Complex Financial Products 32.2 What are Derivatives? 32.3 Variants of Derivative Contracts Forwards/Forward Contracts Futures/Future Contracts Difference between Forward and Future Contracts Options/Option Contracts Difference between Futures and Options

20 Contents xxv 32.4 Economic Role of Derivatives 32.5 Derivative Instruments in India 32.6 Credit Derivatives Forms of Credit Derivatives Significance of Credit Derivatives Benefits of Credit Derivatives Risks Involved in Credit Derivatives Credit Derivatives and Sub-prime Crisis of Credit Derivatives in India 32.8 Asset Securitisation Advantages of Securitisation Pitfalls of Securitisation PART V: APPENDICES Appendix 1: Internet Banking: Techniques and Risk Management Appendix 2: Global Financial Crisis: Impact on India and Policy Response PART VI: GLOSSARY, BIBLIOGRAPHY AND INDEX Glossary of Money, Banking and Finance Bibliography Index