G Padmanabhan: Global convergence of banking regulations and its
impact on the Indian banking system
Address by Mr G Padmanabhan, Executive Director of the Reserve Bank of India, at the
Bankers Club, Raipur, 13 July 2012.
* * *
Assistance provided by S/Shri P R Ravimohan, Nirmal Chand and D Kamatchi Pandian gratefully acknowledged.
I am very happy to be here to address the Bankers Club at Raipur. Chhattisgarh is a fast
developing state and the banking system here has to play its role in ushering in economic
growth of the state. The outreach programme in which I participated yesterday at Makanpur
was an eye opener for me regarding the active role played by the banks towards this
direction.
Global financial crisis - A curtain raiser
As we are passing through difficult but challenging times as far as the financial sector is
concerned, I thought of sharing with you some of the issues which are currently engaging the
attention of the regulators around the world including the Reserve Bank of India for ensuring
the stability and resilience of the financial sector. Though, it has been analyzed threadbare in
different fora, it would not be out of place to start with a bird's eye view of the global financial
crisis to put the recent developments in proper perspective.
The global financial crisis, though brewing for a while, started to show its severe effects from
the latter part of 2007 and into 2008. Under its impact, world stock markets fell, large
financial institutions collapsed or were bought out and Governments in most developed
countries had to use public funds to formulate rescue packages to bail out their financial
systems. There has been a broad consensus that regulatory failures are among the causes
underlying the recent global financial crises. Some of the more salient weaknesses identified
as drivers of the turmoil include lack of oversight of systemic risk, over-reliance on credit
rating agencies, procyclical tendencies of regulatory frame work, shortcomings in risk
management practices, laxity in oversight of shadow banking entities, financial innovation
outpacing regulation and weaknesses in accounting and disclosures.
As a result, there has been an international endeavor to strengthen regulation of banks and
financial institutions and bring about a greater element of convergence therein. Against this
backdrop, firstly, I would outline the drivers for changing regulation of banks. Secondly, I
would briefly present the global efforts aimed at formulating a regulatory reform agenda.
Thirdly, I would analyze the likely impact of the evolving convergence in terms of
implementing the said-agenda. Fourthly I will touch upon certain issues which are specific to
Chhattisgarh before concluding my speech.
Regulatory reforms - A global endeavour
The magnitude of this crisis has clearly signaled the need for major overhaul of the global
financial regulatory architecture. The G-20 leaders have mandated the international
regulatory agencies and standard-setters, including Basel Committee on Banking
Supervision (BCBS), Financial Stability Board (FSB), Committee for Payment and Settlement
Systems (CPSS) and International Accounting Standards Board (IASB) to take active part in
this process. The Washington Summit of G-20 in November 2008 was the first global
initiative in this regard. Subsequently, various committees were set up to make relevant
recommendations. Amongst the most influential reports on the subject are:
i. Report of the High Level Group on Financial Supervision in the European Union
(Chairman: Jacques de Larosiere)
ii. The structure of Financial Supervision: Approaches and Challenges in a Global
Market Place (Group of Thirty - Chairman: Paul Volcker)
iii. The Fundamental Principles of Financial Regulation (The Geneva Report)
iv. The Turner Review: A Regulatory Response to the Global Banking Crisis (Financial
Services Authority of the UK)
v. The Report of Working Group I of the G-20 on "Enhancing Sound Regulation and
Strengthening Transparency (G-20)"; and finally
vi. Principles for Financial Market Infrastructures (CPSS and IOSCO)
Responding to the unfolding situation, international regulatory agencies are working on
strengthening the resilience of financial system, especially on bridging the gaps in the
regulatory framework revealed by the current crisis. The broad contours of the international
initiatives on regulatory reforms envisage strengthening the quality of capital, introducing
minimum liquidity standards and leverage ratio, countercyclical measures in the form of
capital buffers and forward looking provisioning, developing a framework for systemically
important entities including cross-border resolution arrangements, extending the regulatory
perimeter to unregulated pools of money, de-risking the OTC derivatives trading through
central counterparties and new framework for regulating employee compensation within the
financial sector.
This crisis has underscored the importance of effective contingency planning and open
cross-border dialogue between authorities. Lack of information can quickly lead to
uncoordinated measures to the detriment of all. Under the aegis of the FSB, central banks,
supervisors and Governments are maintaining close dialogue and co-operation during this
period of heightened uncertainty. The overarching objective of the recommendations of the
above mentioned committees has been to reduce the probability of occurrence of the crisis in
future and to enable the banking industry to withstand in case crises are to occur. Drawing
from these recommendations, the major stands of the regulatory reforms underway are:
i. BCBS has formulated what is called the Basel III framework aiming at increase the
resilience of banks through prescription of a higher quality, quantity, consistency and
better risk coverage of capital.
ii. The set of reforms for Systemically Important Financial Institutions (SIFIs) are aimed
at reducing the probability of failure of these large and complex financial institutions
and at putting in place a robust resolution framework so that the institutions can be
winded down in an orderly manner, should they fail.
iii. Regulatory perimeter issues are being addressed by putting in place a regulatory
framework for the shadow banking system.
iv. Another set of reforms are aimed at strengthening financial market infrastructures by
addressing issues in the OTC derivatives markets by ensuring that the transactions
in these markets are reported, centrally cleared and, where possible, settled through
a central counterparty.
v. A macro-prudential overlay to the entire regulatory framework is being proposed to
address issues related to procyclicality and the cross sectional dimensions of
systemic risks. Most importantly, organized frameworks for pursuit of financial
stability and crisis management, which promote inter agency co-operation, are being
put in place both nationally and internationally.
vi. The G-20 Leaders re-emphasized the importance of achieving a single set of high
quality global accounting standards and called on the International Accounting
Standards Board (IASB) and the Financial Accounting Standards Board (FASB) to
complete their convergence project in areas where differences still persist
(impairment, fair value/amortized cost approach for classifying and measuring
financial instruments). Similarly, BCBS and IASB should coordinate for fine tuning
countercyclical provisioning within modified accounting standards.
vii. G-20 members, with their resolve to align compensation with prudent risk-taking,
particularly at significant financial institutions, endorsed the FSB Principles and
Standards on compensation. In May 2011, the BCBS has published the final report
on "Range of Methodologies for Risk and Performance Alignment of Remuneration"
and in July 2011, the BCBS in consultation with FSB has also published Pillar 3
disclosure requirements for remuneration.
Notwithstanding the fact that globally, these reforms are at different stages, the broader
endeavour has been to achieve a greater degree of convergence in banking regulation
across jurisdictions with a view to address the issue of regulatory arbitrage. A similar
international effort is underway with regard to payment and settlement systems. As you are
all aware, the one crucial segment of infrastructure which functioned effectively during the
financial crisis was the payment and settlement system infrastructure. Payment Systems are
the channels through which liquidity risks can get exacerbated and could very quickly turn
into credit and systemic risks. In this sphere of payment systems, the measures taken by
central banks the world-over in strengthening risk management in payment systems by
introducing Real Time Gross Settlement Systems and encouraging the private sector to set
up CLS Bank for PvP transactions for settling foreign exchange transactions is indeed
laudable.
It was therefore found expedient in the wake of the financial crisis to revisit the existing three
sets of standards which have guided the development of risk management standards in
payment systems and securities settlement systems. Together the two international-standard
setting bodies in this area the Committee on Payment and Settlement Systems (CPSS) and
International Organization of Securities Commissions (IOSCO) have published the
"Principles for Financial Market Infrastructures" (PFMI) in April 2012. The PFMIs replace the
three existing sets of international standards set out in the Core principles for Systemically
Important Payment Systems (CPSS, 2001); the Recommendations for Securities Settlement
Systems (CPSS-IOSCO, 2001); and the Recommendations for Central Counterparties
(CPSS-IOSCO, 2004). The CPSS and IOSCO have strengthened and harmonized these
three sets of standards by raising minimum requirements, broadening the scope of the
standards to cover additional risk factors, and extending the scope to new types of FMIs
such as Trade Repositories.
The 24 principles outlined in this report are categorized into nine broad categories:
(a) general organization (b) credit and liquidity risk management (c) settlement (d) CSDs and
exchange-of-value settlement systems (e) default management (f) general business and
operational risk management (g) access (h) efficiency and (i) transparency.
Additionally CPSS-IOSCO has released the (i) the CPSS-IOSCO Assessment methodology
for the principles for FMIs and the responsibilities for authorities and (ii) the CPSS-IOSCO
Disclosure framework for FMIs for public consultation with a 60 days comment period. The
public consultation period ended June 15, 2012. Based on the comments received the
Assessment Methodology and Disclosure Framework will be updated and the final versions
of both the documents will be released in end 2012. The PFMIs, along with the Assessment
Methodology and the Disclosure Framework will form the bedrock for assessing whether a
country's Payment and Securities Settlement Infrastructure are compliant.
It would not be out of place to mention here that RBI as a member of the Steering Group
which drafted the Principles made contributions to this endeavor. CPSS and IOSCO
members are expected to strive towards adopting the new PFMI standards by the end of
2012. We in the Reserve Bank with the co-operation of our banking industry partners are
fully geared to meet this challenge. Consistent with our international commitments to the
G-20 and the Financial Stability Board, on OTC Derivatives Market reforms, we are rapidly
moving towards implementing a centralized clearing and settlement framework for IRS
trades. The Clearing Corporation of India Limited (CCIL) would act as the CCP for IRS
trades. Additionally, the industry is moving towards guaranteed settlement of forex forwards
as well.
Simultaneously, the Reserve Bank has also authorized CCIL to act as a Trade Repository for
all forex and interest rate derivatives. This is in addition to its existing function as a Trade
Repository for Credit Default Swaps.
What I have provided is a broad-brush canvas of the myriad developments taking place in
the international area on harmonization and development of better standards for risk
management both in the area of supervision and regulation of banks and financial institutions
and in payment and settlement systems.
Regulatory convergence and its impact on India
The direct effect of the global financial crisis on Indian banks/ financial sector was muted
because of limited exposure of our banking industry to complex innovative products and
other prudential policies put in place by the Reserve Bank of India. The relatively lower
presence of foreign banks in the Indian banking sector also minimized the direct impact on
the domestic economy. India is exposed to the spill-over effects of the regulatory polices
adopted by the systemically important jurisdictions in the World. Volatile cross-border capital
flows are one such manifestation. To the extent that these systemically important
jurisdictions harmonize and converge to agreed international best practices, there could be
positive externalities from the Indian stand point.
The need for convergence in banking regulation stems from the fact that while banking has
become global, banking regulation is national. Therefore, addressing the issue of regulatory
arbitrage is at the centre-stage of policy concern. The international standard setters have
been attempting to achieve convergence by issuing broad principles that should inform
national regulatory frameworks, which are peer reviewed under the aegis of the Financial
Stability Board and the Basel Committee on Banking Supervision for ensuring cross-border
harmonization. While formulating national regulatory policies, national authorities are
expected to exercise constrained discretion on certain aspects.
As regards adoption of global regulatory reform agenda by India, it needs to be mentioned
that a number of measures based on the principles that are now accepted internationally
were already brought into practice even before the recent crisis. These included stringent
liquidity requirements, countercyclical prudential measures, not recognizing in Tier I capital
many items that are now sought to be deducted internationally, amortization of profits from
sale of securitized assets to SPVs over the life of the securities issued, not reckoning
unrealized gains in earnings or in Tier I capital, etc. The same applies to payment and
settlement systems as well.
Notwithstanding the above, the adoption of new principles will no doubt pose challenges in
certain areas. A concern which has been raised globally is that the adoption of Basel III
capital requirements by banks would push down their RoE to an extent. This could have
implications for investments into the banking sector. However, it is expected that by looking
at the benefits of implementation of Basel III capital requirements by way of increasing
resilience of the banking system, investors will get adjusted to the new reality. Though Indian
banks have an undisputed advantage of a strong starting base in the form of a higher CRAR
with a larger component of Core Equity Capital therein, going ahead raising additional capital
would be a big challenge. This has to be overcome by carefully calibrated capital planning
exercise by the management of banks and RBI and the Government of India being the owner
of public sector banks will have to play a proactive role in this process.
The broader endeavour of global convergence in the banking or payment system regulations
would, however, have to account for the country-specific idiosyncrasies to enable customized
adoption of guidance of international standard setters as already recognized in many cases.
For instance, the BCBS guidance on the conduct of the countercyclical capital buffer for India
may require some adjustment/changes as the recommended matric of credit-to-GDP ratio
could potentially adversely impact the structural drivers underlying credit growth in India.
Thus, there may be a need for some adjustments to capital buffer guidance. Similarly the
impact of new capital and margining rules for CCPs and OTC derivatives may require
readjustments in India. Again the developments relating to Trade Repositories and Lead Entity
Indicator approach to trades have implications for India. These aspects are being examined
within RBI.
Issues specific to Chhattisgarh
Economy and banking scenario of the state
Chhattisgarh is one of the youngest States of the Indian Nation. Constituted on
1st November, 2000, Chhattisgarh is located in the heart of India, and shares its borders with
six States. I was very happy to note that Chhattisgarh has featured among the top 5 states in
GDP growth for the past three years, in which the States GDP growth has been in double
digits. As on March 31, 2012, there were 36 Commercial Banks (Public Sector and Private
Sector), 3 Regional Rural Banks, 6 District Central Co-operative Banks and 12 Urban
Co-operative Banks, operating in Chhattisgarh in addition to the State Co-operative Bank
and State Co-operative Agriculture and Rural Development Bank. The total number of bank
branches in the State was 1912 as on the same date.
It is gratifying to note that 22 districts out of 27 have achieved 100% financial inclusion.
Remaining districts viz. Rajnandgaon, Dantewada, Bijapur, Narainpur and Sukma suffer from
Left Wing Extremism (LWE) and progress is relatively slower in these districts. There has
been a consistent growth in the deposits and advances of banks over the last five years but
the CD ratio remains below the expected level of 60%. Another significant factor is that
Chhattisgarh has been one of the few States where the target for provision of banking
services to villages having population above 2000 has been achieved. There were
1050 villages identified for provision of banking services by March 2012.
Opportunities in Chhattisgarh
The State has huge deposits of minerals. It is one of the few power surplus States in the
country. The gender ratio is above the national level (991:1000). Literacy ratio is 71.04%
(Male - 81.45%, Female - 60.59%) and it has improved considerably subsequent to the
formation of the State. Steady GDP growth over the past few years has created a good
investment climate in the State. Chhattisgarh with its immense natural beauty has got the
potential to be one of the best tourism destinations in the country.
Challenges
The economy of the State is primarily agricultural but a major part of the agricultural land is
mono-cropping in the absence of sufficient irrigation facilities. In order to bring more land
under multi-cropping, minor irrigation schemes should be focused upon. KCCs need to be
made available to all eligible farmers and we are quite far from that target. In cases where
proper land records are not available or cases pertaining to "share croppers/oral lessees",
Joint Liability Groups (JLG) need to be formed so that crop loans are made available to these
farmers. Farm mechanization is the need of the hour, as without modern techniques and
implements productivity cannot be enhanced. Chhattisgarh has been an under performer as
far as Agricultural Term Loans (ATLs). Banks need to bring in more region specific products
so that ATL off-take is increased and field level functionaries need to be sensitized that there
is more to agricultural credit than just crop loans.
Besides agriculture, MSME is the second largest sector as far as employment is concerned.
The Empowered Committee on MSME in Chhattisgarh has done a fairly good job and the
State has witnessed a steady growth in loans to this sector. Subsequent to the
recommendations of High Level Task Force by Prime Minister, there is an increased focus
on Micro and Small Enterprises (MSE). They are present in the State but the spread of these
industries is very limited and keeping in view the huge employment potential in these
industries, growth of MSEs should be facilitated by banks and Government. Workshops,
meetings and sensitization programmes elaborating various Government sponsored
schemes, banks schemes and availability of collateral free loans should be organized in each
block.
Education loans should be extended to all eligible students. Recently a news item mentioned
that, more than a hundred students from tribal community residing in LWE areas got selected
for engineering colleges. It is a great step forward and to ensure that such a process
continues, the financial sector should provide all possible assistance.
Financial inclusion has been a key performance area for all of us since the last few years.
Chhattisgarh has made good progress on this front as 22 out of 27 districts have achieved
100% financial inclusion and the remaining districts are expected to achieve this target soon.
Bankers and Government agencies deserve appreciation for having achieved the target of
provision of banking services to villages having population more than 2000. This is just the
beginning, we need to go miles and there is no room for complacence. Opening at least one
bank account in each family and providing banking services through business correspondent
are the initial steps, we need to make sure that people develop a habit of banking. Their
credit, remittance and insurance related needs are met and financial products delivered at
their doorstep. Financial literacy and awareness plays a vital role in holistic financial
inclusion. Bankers and Government agencies need to incorporate financial literacy as a part
of their action plans at all levels. RBI has been organizing Outreach and similar programmes
but they are just to show the way, it is for the banking industry to take it further to each and
every village. A proper schedule for such programmes may be prepared and RBI would
extend all possible assistance to such initiatives by banks. Financial Literacy and Credit
Counseling centers are being set up at district levels, the functioning of these FLCCs should
be monitored closely by controlling heads of banks and necessary guidance should be
provided. FLCCs should not function only at their office but they need to step out at rural
markets, gram sabhas and schools to educate people about financial products.
Looking at the banking statistics for the past five years it is observed that there is a gradual
reduction in CD ratio. For a State featuring among the top in economic growth it is not
comforting to note that the CD ratio is declining. It might be because of investments being
made in the State resulting in greater growth of deposits. It has been mentioned that few
large projects operating in the State have credit limits sanctioned from other States hence
they cannot be included in advances for Chhattisgarh. Bankers need to address this issue,
with CBS any customer can access his account from any branch, and this can be utilized by
bankers in Chhattisgarh to sanction big ticket advances. Banks should have an area specific
action plan for growth in advances keeping in view the huge potential available in the State.
The State Government has signed MoUs with some major industries and they are likely to
setup their project here, this opportunity should be grabbed by banks to boost up their
advances. Business correspondents can also play a major part in increasing credit; banks
can extend overdraft facility to MGNREGA workers. Keeping in view the huge number of
such beneficiaries the resultant credit growth will be substantial.
Concluding observations
In view of the fact that regulatory failures are among the causes for the recent global financial
crisis, globally, an endeavour has been underway to adopt regulatory reform agenda and
thereby achieve a broad convergence of banking regulation across jurisdictions. The
prospects of regulatory convergence could have positive implications for India as it could
potentially address the negative spill-over effects of regulatory policies adopted by
systemically important jurisdictions. However, the paradigm of regulatory convergence has to
accommodate national imperatives of the individual jurisdictions to account, inter alia, for
divergence in their stages of economic development, status of their financial markets and
infrastructure. I would conclude by summing up the challenge in front of us by saying that the
need of the hour is to think globally but act locally. In this backdrop it is important that all the
regions of India are brought to the same level of economic growth and the banking sector
has to play a catalystic role in this endeavour. I am sure that the banking system in
Chhattisgarh will be able to meet this challenge and make this State a very prosperous and
vibrant one in the coming days.