Evolution of financial markets in India: Charting the Future
Keynote Address by Shri Shaktikanta Das, Governor, Reserve
Bank of India, at the FIMMDA-PDAI Annual Conference, April 8,
2024, Barcelona
It is my pleasure to be here at the FIMMDA-PDAI annual conference.
This year (2024-25) is particularly special for the Reserve Bank. The
RBI has entered its 90th year on April 1, 2024. I, therefore, thought it
appropriate to dwell upon the journey of the Reserve Bank, especially
in the context of its role in developing the financial markets in India
in the recent period. I also propose to share some of my thoughts on
the way forward.
2. To give a brief background, the Reserve Bank was set up in
1935 on the recommendations of the Hilton Young Commission with
the objective of regulating the issue of bank notes, securing monetary
country's
stability and operating the currency and credit system. The
statutory basis for its functioning was provided by the Reserve Bank
of India Act, 19341. The nationalisation of the Reserve Bank, which
had started as a joint stock company took place in 1949.
3. Over the years, the Reserve Bank has performed a wide range
of functions to support the Indian economy. Its developmental role
came into focus during the planning period, when one of its major
roles was to channelise credit to the needy sectors of the economy.
With the commencement of the process of liberalisation in the 1990s,
the Reserve Bank focused more sharply on core central banking
functions like monetary policy, regulation and supervision of the
financial sector, development of financial markets and payment
systems. Today, the RBI is a full service central bank and an enabler
of the market economy.
4. The journey of the Reserve Bank and its focus on emerging
areas has been reflected in the amendments to the RBI Act, 1934
and various other statutes from which the Reserve Bank draws its
mandate. The notable changes over the last couple of decades
include the statutory amendments for (i) strengthening the legal
framework for oversight of non-banking financial companies (NBFCs)
(1997)2; (ii) consolidating the laws related to government securities
into Government Securities Act (2006)3; (iii) providing the legal
framework for regulation of key financial markets (2006)4; (iv)
enactment of the Payment and Settlement Systems Act to vest the
Reserve Bank with the authority to regulate and supervise the
payment systems in India (2007)5; (v) institutionalisation of the
flexible inflation targeting framework (2016)6; (vi) vesting the
Reserve Bank with the authority to regulate housing finance
companies through an amendment of the National Housing
2
In response to the perceived need for better regulation of the NBFC sector, the Reserve Bank of India
(RBI) Act, 1934 was amended in 1997, providing for a comprehensive regulatory framework for NBFCs.
The RBI (Amendment) Act, 1997 conferred powers on the RBI to issue directions to companies and its
auditors, prohibit deposit acceptance and alienation of assets by companies and initiate action for
winding up of companies.
3
The Government Securities Act, 2006.
4
The RBI Act was amended to insert Chapter III D (Section 45U, V, W and X,), providing Reserve Bank
the power to regulate transactions in money market, government securities market and the foreign
exchange, rupee interest rate and the credit derivative markets.
5
The Payment and Settlement Systems Act, 2007
6
The Act was amended in 2016, to provide for a statutory and institutionalised framework for a Monetary
Policy Committee, for maintaining price stability, while keeping in mind the objective of growth.
Bank Act, 1987 (2019)7; (vii) strengthening the regulatory
framework for cooperative banks by amendment of the Banking
Regulation Act, 1949, (As Applicable to Cooperative Societies)
(2020); and (viii) enabling the issuance of the central bank digital
currency (2022)8. These changing priorities and the quest to keep
pace with developments, including technological changes, have
been reflected in the Reserve Bank's organisational structure,
examples of which include the setting up of the Department of
Payment and Settlement Systems (2005); the Financial Stability Unit
(2010), now called the Financial Stability Department; the Financial
Markets Regulation Department (2014); the Financial Market
Operations Department (2014); and the FinTech Department (2022).
Financial markets: Fostering trust, stability and innovation
5.
Let me now focus on the journey of our financial markets, a
journey in which the Reserve Bank has collaborated with many
stakeholders including the FIMMDA and the PDAI who have been
Reserve Bank's
valuable partners in the endeavor to develop
markets, institutions and practices.
6. The onset of the Global Financial Crisis (2008) altered the way
the world looked at financial markets. At that stage, our financial
markets were just beginning to develop, buoyed by the needs of a
growing economy and in the background of the transition to market-
determined interest rates and exchange rates, convertibility in the
current account and gradual liberalisation of the capital account.
Significant institutional and market infrastructure developments had
also taken place. These included the setting up of the Clearing
Corporation of India Limited (CCIL) and the operationalisation of
RTGS, the NDS-OM platform and a trade repository for derivatives.
Nonetheless, the markets remained in the early throes of
development. Bank-intermediated finance was the preferred funding
option. Diversity in financial products and participants was limited.
The approach to foreign participation in domestic markets was
economy's
guarded. At the same time, the growing aspirations was
placing increasing demands on financial markets while successive
global crises necessitated prudent risk management. Meanwhile,
global interest in the Indian Rupee, and the offshore Rupee markets,
continued to grow. The onshore and offshore Rupee markets
remained segmented.
the Reserve Bank's
7. Against this backdrop, efforts in recent
years to develop the financial markets focused on meeting the needs
of a more confident and aspirational economy. Our reform
endeavours have also fostered trust, stability and innovation by (i)
making capital raising more efficient; (ii) removing segmentation
between onshore and offshore markets; (iii) expanding the
participation base by easing access to markets for hedging and
expressing views on market movements; (iv) promoting innovation
through a larger suite of products; (v) ensuring the integrity and
resilience of markets and market infrastructure; and (vi) ensuring fair
conduct by market participants.
8. Let me discuss the major reforms undertaken in the recent
years.
Markets for Funding
Government securities market
9. A key objective of the Reserve Bank has been to foster a robust
G-sec market and yield curve, which I have often referred to as a
public good. A Benchmark Security Issuance Strategy9 was
introduced in 2020 to facilitate the development of the yield curve by
providing liquidity at important tenor points. Last year, monthly
(instead of fortnightly) issuance of select G-secs was commenced to
widen the window between successive auctions and foster greater
liquidity.
10.
The regulatory frameworks for the 'when issued' market10 and
short selling in G-secs11 were liberalised to enable better
management of auction risk and price discovery (2018). The Request
for Quote (RFQ) dealing mode on NDS-OM was introduced to enable
market participants to negotiate trades electronically (2020).
Sovereign green bonds were introduced in January 2023. Lending
and borrowing of G-secs was also permitted to facilitate wider
participation by different classes of investors in the securities lending
market12.
11. The Reserve Bank, in consultation with the Government, has
been progressively liberalising the regulations for foreign investment
in G-secs. The Fully Accessible Route (FAR) was introduced to
enable Foreign Portfolio Investors (FPIs) to invest in specified G-secs
without restrictions (2020)13. The suite of specified securities under
FAR was enhanced (2022 and 2023)14. Measures were also taken to
facilitate "ease of doing business" by
FPIs. For instance, extended
timings were allowed for reporting of transactions15 and banks were
permitted to fund margins for G-Sec trades of FPIs16. These
measures contributed to the recent inclusion of Indian G-secs in
certain global bond indices reflecting a growing confidence of global
investors in the Indian financial markets and the economy.
12. Measures have been taken to expand retail participation in G-
'RBI Retail Direct'
secs. The scheme, launched in 2021, have
enabled individuals to directly access the primary and secondary G-
sec markets, including sovereign gold bonds and floating rate
savings bonds. A market-making arrangement through primary
dealers has been put in place. The National Automated Clearing
House (NACH) facility has been introduced allowing investors to
create a one-time mandate and use it multiple times for making
payments (December 2023). As announced in the recent monetary
policy statement on April 5, 2024, a mobile app for accessing the
Retail Direct portal will be launched shortly.
Corporate bond market
13. The Reserve Bank, with co-operation from other stakeholders,
has been making efforts to develop a vibrant corporate bond market
which is an important enabler of longer-term funding. To attract
greater non-resident participation in corporate bonds, the FPI
investment limit in corporate debt under the Medium-Term
Framework was increased from 9% to 15% of outstanding corporate
bonds (2020)17. The Voluntary Retention Route (VRR) was
introduced in 201918. The regulatory framework for repo in corporate
bonds was rationalised in 201819. Legal recognition was provided for
bilateral netting of repo in corporate bonds and credit derivative
contracts through requisite notifications under the Act for Bilateral
Netting of Qualified Financial Contracts, 2020. The regulatory
framework for credit derivatives was revised in 202220. The AMC
Repo Clearing Limited was authorised to offer tri-party repos in
corporate bonds in 2023. The measures taken by the Reserve Bank
during the COVID-19 pandemic, especially the liquidity measures like
the Long Term Repo Operations (LTROs), the Targeted Long Term
Repo Operations (TLTROs) and the TLTRO 2.0 were also critical in
ensuring that the market continued to function smoothly.
Money markets
14. The regulatory framework for the markets for call, notice and
term money; certificates of deposits (CDs); commercial paper (CP)
and non-convertible debentures (NCDs) with original maturity up to
one year, was comprehensively rationalised in April 2021, June 2021
and January 2024 respectively. The participant base was widened
by extending access to the call, notice and term money markets to
Payment Banks, Small Finance Banks21 and Regional Rural Banks
(RRBs)22. The RRBs were also permitted to issue CDs23. To foster
efficiency, call money market participants have been mandated to
obtain membership of the NDS-Call platform24. Banks have been
provided the flexibility of setting their own limits for call and notice
borrowings within the prudential limits for inter-bank liabilities25 and
the option of buying back CDs. The operational requirements for CPs
and NCDs with original maturity up to one year have been eased,
and compliance and disclosure requirements strengthened26.
Development of OTC Derivative Market
15. The regulatory framework for OTC transactions in interest rate,
FX and credit derivatives has transformed over the last few years27.
The revised framework is based on the principles of easing access
and operations, enabling flexibility and ensuring fair market conduct,
customer protection, transparency and risk management, while
eschewing detailed procedural prescriptions.
16. Access to financial markets has been eased. Non-residents can
now access the domestic markets at par with residents. Large
participants (non-retail users) can access derivative markets to
hedge their risks as also express views28. The market-maker base
has been expanded by granting authorised person licences to
standalone primary dealers. Market-makers have been permitted to
offer bespoke or custom-made products to enable efficiency and
flexibility in hedging, subject to necessary risk management
capabilities. Retail customers can only be offered a set of simple
products. New products such as interest rate options, swaptions and
FX swaptions have been permitted. Non-deliverable FX derivatives
can be offered to residents for hedging29. It is expected that market-
makers and banks exercise due caution and diligence while
designing and offering such products to customers, keeping in mind
the profile of customers.
17. A significant policy initiative has been to permit the banks to
access offshore INR markets for (i) FX derivatives (in 2020)30, subject
to the presence of an operating IFSC Banking Unit (IBU); and (ii) for
interest rate derivatives (in 2022)31 with a view to improve the
efficiency of price discovery and provide greater opportunities to
domestic participants. Market-makers have been permitted to deal in
such products beyond domestic markets hours. Rupee derivatives
settled in foreign currency have also been permitted in GIFT City,
both through OTC markets and on the exchanges.
Integrity of markets and market infrastructure
18. Ensuring the integrity of financial markets and market
infrastructure has underpinned many reform initiatives of the Reserve
Bank.
19.
A framework for authorisation of electronic trading platforms
was put to place in 201832 to ensure that only entities adhering to a
robust set of conditions function in RBI-regulated financial markets.
This framework is being updated in view of the recent developments
in technology that have accelerated the electronification of financial
markets. Considering the complaints of cheating and fraud by
unauthorised trading platforms, necessary cautionary advice has
been issued against undertaking forex transactions on such
'Alert List' of entities offering
platforms33. An or promoting
unauthorised forex trading facilities has also been issued34.
20. A risk-based regulatory framework for benchmark
administrators was put in place in 201935 and fine-tuned in 202336 to
ensure robust governance in benchmark administration in RBI-
regulated markets. Regulations for market abuse were put in place
in 201937. Similar frameworks have been put in place for (i)
governance, risk management and conduct, including customer
suitability and appropriateness assessment by market-makers in
OTC derivatives (2021)38; and (ii) margins for non-centrally cleared
derivatives. Exchange of variation margin was mandated in 202239.
The framework for exchange of initial margin will be issued shortly.
21. Requirements for transparency in pricing of OTC derivative
products for retail investors were also set out. In 2019, the FX Retail
platform was introduced to create a market infrastructure that would
ensure fair and transparent pricing40.
Way forward
22. The recent financial market reforms undertaken by the Reserve
Bank are aimed at providing a strong bedrock for markets to move to
the next trajectory for meeting the growing funding requirements in
the economy, providing cost effective hedging options and competing
effectively in global markets.
23.
The response to the regulatory measures has been
encouraging. The participation base has been widening. Retail
participation in G-secs through the Retail Direct scheme has been
growing. The VRR scheme has attracted interest from FPIs,
especially for corporate bonds. In recent months, robust foreign
inflows in G-secs have been witnessed. Non-resident participation in
OTC derivative markets has increased, adding to liquidity and
diversity. Many of you have started participating in the offshore
derivative market for the INR. Prices and spreads in the domestic
and overseas markets have converged to a great extent.
24. There are, however, some areas which call for attention. While
lot of progress has been made by banks and other market
participants, I wish to highlight six specific areas where more can be
done. First, participation of domestic banks in derivative markets
remains limited with only a small set of active market-makers.
Participation of Indian banks in global markets is growing but it is
quite small. Domestic banks are dealing with market-makers in global
markets rather than with end clients and are yet to emerge as market-
makers of note globally. Of course, banks need to do their own due
diligence, assess their risk appetite, and then move forward carefully
in this direction. Going forward, our focus should be on enhancing
and widening the participation of Indian players in markets for INR
derivatives, both domestically and offshore, while being prudent.
25. Second, liquidity in OTC derivatives markets, especially interest
rate derivatives, remains confined to a few products, constraining
efficient hedging by the larger economy. The market for credit
derivatives which is an important enabler for the lower rated
corporate bonds is yet to take off. I am, however, happy to note that
the first credit default swap (CDS) transaction after the issuance of
the revised guidelines came into effect in May 2022 was undertaken
last week. In many ways, all domestic market participants are yet to
fully embrace the new regulatory framework and exploit the
opportunities it presents.
26. Third, transparency in pricing remains work in progress and
more can be done. The retail customer is yet to get a deal at par with
large customers. There is a need for effective market-making and
finer pricing for smaller deals on NDS-OM. Divergence in pricing in
FX markets for the small and large customers are wider than what
can be justified by operational considerations. Banks may need to do
more to facilitate the use of the FX Retail platform. We continue to
see banking channels being used by certain persons or entities to
fund activities on unauthorised FX trading platforms. This warrants
enhanced vigilance by the banks.
27. Fourth, efforts are being made to leverage technology for
achieving greater efficiency while also meeting the objectives of
market reforms. For example, we are exploring the use of
technological platforms to expand the reach of financial markets, in
particular the reach of the RBI Retail Direct and FX Retail. In the
derivative markets, efforts are underway to introduce electronic
trading platforms for a larger number of derivative products and to
expand the central clearing of products. To foster greater efficiency,
Application Programming Interfaces (APIs) for reporting trades to
NDS-OM and accessing the RFQ dealing mode are being
contemplated. Introduction of bond forwards is being considered to
enable long-term investors to manage their interest rate risks
-
efficiently draft guidelines in this regard were issued in December
202341. The Reserve Bank remains engaged with stakeholders to
assess the need for the introduction of new products and
infrastructure based on evolving market developments.
28. Fifth, bank treasuries need to scale up their dynamism to utilise
the opportunities presented in the context of the recent regulatory
reforms. This is very critical for achieving efficient market
intermediation, effective management of financial risks and
alignment of financial variables across different segments and
markets. From this financial year (2024-25), the new prudential
framework for investment by banks has come into effect. The new
regulations provide increased flexibility to banks in managing their
treasuries and offer scope for increased efficiency, provided banks
manage their treasury function actively. The framework of
bank's treasury
assessment of a should take into account risks
arising out of action and risks arising out of inaction i.e., missed
opportunities.
29.
Sixth, appropriate safeguards should be put in place to address
the new challenges posed by new products, participants and
markets. For example, as sophisticated OTC derivative products are
introduced, they must be accompanied by adoption of certain
safeguards, both by the market-makers as well as customers. As our
markets get integrated with global markets and non-resident
participation increases, transmission channels from global
developments will become stronger and speedier. This will require
greater watchfulness and proactive management of the associated
risks by market participants even as the opportunities are grabbed.
Conclusion
To conclude, the Reserve Bank's efforts in recent years
30. has
been to develop the financial markets in a manner that can continue
to meet the needs of a growing and globally connected economy
while fostering trust, stability and innovation. Trust in financial
markets has been sought to be promoted through market reforms
which have focused on ensuring fair market conduct by preventing
market abuse; fair customer conduct through robust market-marking
regulations and ensuring price transparency; and enhanced
disclosures by market participants. Stability in financial markets has
been made possible by ensuring orderly functioning of the financial
markets and financial market infrastructure42. Innovation has been
sought to be promoted through a move towards principle-based
regulation, widening of the participant base, introduction of new
products and platforms as well as enabling access to offshore
markets.
31. The achievement of desired outcomes will be contingent on
financial institutions and market participants taking forward the
reform agenda so that we have vibrant and internationally
competitive financial markets. Market participants and their
associations including FIMMDA and PDAI will have to play a critical
role in this.
32. As we look forward to the next decade coinciding with
RBI@100, we have to work together and usher in the next generation
reforms to place India at a position it rightly deserves.
Thank you.