Turnaround of the Indian Banking System

Keynote Address by Shri Shaktikanta Das, Governor,
Reserve Bank of India

Delivered at the Mint BFSI summit, January 11, 2024,
Mumbai

I am extremely delighted to be here this morning at the Mint
BFSI Summit. I would like to thank the organisers, Mint, for inviting
me to this event. Incidentally, I had also participated in a similar event

- Mint Annual Banking Conclave - in February 2020.

2. Not very long ago, the Indian banking sector was beset with a
host of issues. Indian banks were weighed down by high levels of
non-performing assets (NPAs),' while the returns on assets and
equity were in negative zone. Eleven banks were under Prompt
Corrective Action (PCA) as at end-June 2018." Failure of a major
Non-Banking Financial Company (NBFC) stoked fear and risk
aversion among market participants leading to increased costs of
market borrowing, especially for those with perceived asset-liability
mismatch concerns. Even as we were coping up with the stress in
the financial sector, the COVID-19 pandemic in the beginning of the
year 2020 came as a shocker, which led to major disruptions across

all sectors.

1 As on March 31, 2018, the gross non-performing assets were around 11 per cent of the
gross advances, after the RBI had done an asset quality review in 2014-15.
2 Financial Stability Report, June 2018


3. During the last five years, the Reserve Bank took a series of
initiatives on the regulatory and supervisory fronts, while banks
themselves, to their credit, responded to the challenges by
strengthening their internal defence mechanisms. As a result of these
concerted efforts, there has been a gradual and consistent
turnaround in the banking system, despite the multiple headwinds
emanating from COVID-19, geo-political conflicts and sharp
monetary policy tightening across the world. All key indicators of
scheduled commercial banks (SCBs), namely, capital adequacy,
asset quality and profitability have shown improvement in the last
four years.* The credit growth has now become broad-based and
backed by the strong fundamentals of the financial institutions. The
financial indicators of non-banking financial companies are also in
line with that of the banking system as per the latest available data.
On the whole, India's banking sector has emerged stronger from the

unprecedented challenges of the recent years.

4. Questions are often raised as to how this turnaround in the
banking sector took place. My short answer to this question is that it
is the result of all the good work of various stakeholders in the
system. In my address today, I have chosen to speak on the Reserve

Bank's efforts to steady the economic ship amidst turbulent waters in

° The capital adequacy of banks has increased by 181 bps from 14.8 per cent as on March
31, 2020 to 16.6 per cent as on September 30, 2023. The asset quality has also steadily
improved with gross non-performing assets decreasing from 8.3 per cent to 3.3 per cent and
the provisioning coverage ratio increasing from 81.2 per cent to 91.9 per cent during the same
period. The profitability, as reflected in the Return on Assets and Return on Equity, too, has
shown an increase of 119 bps and 1131 bps, respectively. The liquidity coverage ratio (LCR)
of SCBs was comfortable at 135.4, much above the minimum stipulation of 100.

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the last few years. I have structured my talk in the following manner.
First, I shall speak on our response to various crises starting with the
non-banking finance companies (NBFC) stress that haunted us even
before the pandemic. Next, I shall dwell upon the body of work we
have undertaken in recent years to revamp our regulation and

supervision.

How We Navigated through the Crisis

5. In the aftermath of the Infrastructure Leasing and Financial
Services (IL&FS) crisis, the Reserve Bank heightened its focus on
maintaining and fostering macro-financial stability through a series of
conventional and non-conventional measures. The __ flexibility
provided in the Flexible Inflation Targeting (FIT) framework of
maintaining price stability, while keeping in mind the objective of
growth, helped us to accommodate large supply side shocks, while
focusing on immediate growth concerns during the pandemic. In
particular, the tolerance band around the target came handy during
this period. While always keeping an eye on the financial stability
concerns, the Reserve Bank endeavoured to ensure that the
economy got back on its feet as quickly as possible and returned to
a higher trajectory of growth. Our ultimate objective is the mutual
coexistence of price stability, sustained growth and financial stability

that works best for the Indian economy.

6. Following the collapse of IL&FS in the second half of 2018,
almost the entire 2019 necessitated taking measures to intensify the
supervision of NBFCs; monitoring their liquidity and_ stability

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conditions more closely; infusing system liquidity through innovative
instruments like currency buy-sell swaps; restoring market
confidence through appropriate communication and backing it up

with actual action on several fronts.*

7. When we envisaged that COVID-19 could be a major disruptive
factor, our response was swift and decisive. A slew of measures was
announced on March 27, 2020. They included targeted term repo
operations (TLTROs) up to %1,00,000 crore, reduction in the cash
reserve ratio (CRR) by 1 percentage point and enhancement of
access to marginal standing facility (MSF) by the banks.° Business
continuity measures were put in place in the Reserve Bank even
before the nation-wide lockdown was announced.° In parallel, all
supervised entities (SEs) were advised in March 2020 to activate
their existing operational and business continuity plans and manage
the risks posed by the COVID-19 pandemic. On the monetary policy
front, the policy repo rate was reduced sizeably by 115 bps in a span
of two months (March-May 2020). Liquidity enhancing measures
equivalent to 8.7 per cent of GDP were announced. As a result of
these measures, financial conditions got substantially eased during
the COV-19 period.

4 In June 2019, during the post policy press conference, the Governor had said clearly that
"...it is our endeavour to ensure that there is no collapse of any large systemically important
NBFC or any large NBFC. And, in that direction we are monitoring the evolving situation and
we will see how it moves forward. ...."

> Banks' limit for borrowing overnight under the MSF by dipping into their Statutory Liquidity
Ratio (SLR) were raised to 3 per cent of NDTL from 2 per cent which allowed them to avail
an additional %1,37,000 crore of liquidity under the LAF window.

® We were perhaps amongst the first few central banks to have set up a special quarantine
facility with about 200 officers, staff and service providers, engaged in critical activities to
ensure business continuity in banking and financial market operations and payment systems.

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8. IThe regulatory focus was to frame appropriate policy responses
to mitigate the immediate impact of COVID-19 on the financial
institutions and their constituents. The regulatory measures
introduced during this period could be broadly grouped into two
categories viz., measures to stabilise the economy against the
onslaught of the pandemic and measures to support a quick recovery

and durable growth in the medium term in the post-pandemic period.

9. To provide immediate debt service relief to borrowers whose
income generating ability was impaired by the lockdowns, a
moratorium on repayment of loans was provided to all eligible
borrowers, initially for a period of three months, which was
subsequently extended by another three months, taking the total to
six months from March 2020 to August 2020. Given that the
borrowers would require additional working capital financing to tide
over the crisis period, lenders were permitted to recompute working
capital requirements of the borrower and finance accordingly. To
incentivise lenders to implement the above measures in its true spirit,
regulatory exemption was provided, in terms of which loan
moratorium and easing of working capital financing were not treated

as restructuring.

10. Further, to facilitate revival of activity in the real sector and to
mitigate the impact on ultimate borrowers, a window under the
Resolution Framework (1.0) was provided to lenders to implement
viable restructuring plans in respect of eligible borrowers without

asset classification downgrade. Given that a similar experience in the

past had led to some adverse experiences, clear eligibility conditions
were codified to ensure that only borrowers impacted by the
pandemic were covered with a defined sunset clause. Additionally,
to ensure that only viable proposals are extended the benefit, an
expert committee was constituted to recommend the required
financial parameters with sector-specific benchmark ranges for such
parameters to be part of the resolution plans. Lending institutions
were required to consider these parameters, in combination with any
other parameters as decided by them, for evaluating the resolution

plans.

11. As the shocks of the second wave of COVID -19 emerged, a
similar window under Resolution Framework 2.0 was announced for
micro, small and medium enterprises (MSMEs); retail loans; and,
loans to other small businesses as well as individuals for business
purposes, having borrowings of less than %50 crores, with well-
defined principles. The two Resolution Frameworks were an exercise
in balancing the interests of creditors and debtors without losing sight
of the prudential and financial stability concerns. With this
background of our immediate response to the crisis, let me now turn
to our efforts towards strengthening the regulatory and supervisory

architecture of the banking system from the long-term perspective.

Strengthening the Regulatory Architecture

12. While dealing with the COVID-19 pandemic related challenges,

we announced and implemented a series of structural measures all

through this period to strengthen our regulatory systems, shifting
from an entity-based approach to more of a principle and/or activity-
based approach. These measures have played a key role in not only
averting a crisis, but also enabling the financial sector and the
economy to emerge stronger and healthier from the multiple crises

that we experienced in the last few years.

13. In the recent period, the Reserve Bank has undertaken a
complete overhaul of the regulatory architecture of the banking
system. These regulatory steps include, among other things, the
implementation of leverage ratio (June 2019)'; large exposures
framework (June 2019)°; guidelines on appointment of directors and
constitution of committees of the board (April 2021)9; revised
guidelines on securitisation of standard assets and transfer of loan
exposures (September 2021); scale based regulatory framework for
NBFCs (October 2021)'°; revised regulatory framework for Urban

7 Keeping in view the requirements of financial stability and increased harmonisation with
Basel Ill standards, it was decided that the minimum leverage ratio should be 4% for Domestic
Systemically Important Banks (DSIBs) and 3.5% for other banks.

8 In order to capture exposures and concentration risk more accurately and to align the
instructions with international norms, the Large Exposure Framework was modified with
notable introduction of economic interdependence criteria in the definition of connected
counterparties and mandatory "look-through approach" in determination of relevant
counterparties in case of structured financial investments.

° The instructions were issued to the scheduled commercial banks about the Chair and
meetings of the board; composition of certain committees of the board; age, tenure and
remuneration of directors; and appointment of the whole-time directors (WTDs).

10 Even before these new regulatory frameworks were brought in, we had taken measures
such as issuance of guidelines on appointment of Chief Risk Officers (CROs) (May 2019) and
Chief Compliance Officers(CCOs) in large NBFCs (April 2022); Liquidity coverage ratios for
NBFCs with asset size of 5000 crore and above (November 2019); risk-based internal audit
(RBIA) norms for large NBFCs (with asset size of 75000 crore and above) and UCBs with
asset size of %500 crore and above (February 2021); and harmonising the guidelines on
appointment of statutory auditors for NBFCs and UCBs with that of commercial banks (April
2021).

Cooperative Banks (July 2022); and guidelines on digital lending
(September 2022). The capital and liquidity requirements are
uniformly applied to all scheduled commercial banks (SCBs),
irrespective of their asset size and exposure.'' We nudged the banks
for achieving complete automation of income recognition, asset
classification and provisioning processes. Notably, while the
guidelines to this effect were issued in 2011, their full implementation
was pending. Further, additional guidelines were issued in 2020 to

ensure the completeness and integrity of this process.

14. I would now like to highlight some of the other facets of the
Reserve Bank's regulatory efforts. There are six points here to which

I wish to draw your attention.

(a) Fostering a Sustainable Digital Lending Landscape

15. Post pandemic, digital lending has seen an exponential rise in
various emerging economies including India. There has been an
increase in scale and velocity of digital credit. At the same time, it has
raised a host of business conduct issues. Consequently, various
regulatory dilemmas have emerged wherein a balanced approach
had to be taken. It was necessary to weigh the customer benefits
brought in by innovative business models of FinTechs on one side
and the emerging business conduct and regulatory concerns on the

other.

1 All SCBs are required to maintain capital to risk weighted asset ratio (inclusive of capital
conservation buffer) at 11.5 per cent, LCR at 100 per cent and NSFR of 100 per cent.

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16. The outcome of the Reserve Bank's regulatory balance was
reflected in the digital lending guidelines issued in September 2022,
followed by the guidelines on First Loss Default Guarantee (FLDG)
in June 2023, covering prudential concerns and other salient facets
of outsourcing, business conduct, data privacy and digital lending
operation. The regulatory objective was to rein in the negative
externalities while retaining the salutary effects of innovative digital
business models. The data on private equity flows into the digital
lending space after the issuance of these guidelines demonstrates
the faith of investors on the Indian digital lending story and the belief
that, going forward, digital lending under the regulatory gaze of the
Reserve Bank will sour the FinTech sector even more. In furtherance
of this objective and as a part of our efforts to accelerate and widen
the reach of digital banking services, the concept of "Digital Banking

Units" (DBUs) was also introduced. '
(b) Firming Up Governance in Regulated Entities

17. Our focus in recent years has been on strengthening the
governance and assurance functions in the regulated entities -
banks and non-bank financial companies (NBFCs) - to enhance their

internal lines of defence. The emphasis has been on building an

12 DBU is a specialised fixed point business unit / hub housing certain minimum digital
infrastructure for delivering digital banking products & services as well as servicing existing
financial products & services digitally, in both self-service and assisted mode, to enable
customers to have cost-effective/ convenient access and enhanced digital experience to/ of
such products and services in an efficient, paperless, secured and connected environment
with most services being available in self-service mode at any time, all year round.

environment of trust, transparency and accountability in the financial
sector. The assurance functions, namely, risk management,
compliance and internal audit are critical links between governance
and business. The key is to identify risks early, monitor them closely
and manage them effectively. In this context, instilling an appropriate
risk culture in the organisation is important. This needs to be driven
by the Board and senior management with effective accountability at
all levels. We expect the senior management, the Board of Directors,
the Audit and Risk Management Committees and the Internal Audit
function in banks to play a more proactive role and be more watchful
of incipient and emerging risks. The Reserve Bank has issued
detailed guidelines for ensuring quality and independence of the
governance and assurance functions. These areas are also

subjected to intensive supervisory assessment.

(c) Reimagining Regulations with a Pro-Customer Perspective

18. We have given renewed focus on strengthening the conduct
related aspects. Instructions have been issued on the responsibilities
of regulated entities to ensure avoidance of intimidation or
harassment of customers by their recovery agents. The Master
Directions on issuance of cards have strengthened the conduct

regulations relating to various aspects of card operations. '%

13 These include closure of a credit card account, issuance of credit card for business purpose,
billing issues, refund of credit transactions, new form factors, issues relating to co-branded
arrangement, mis-selling, etc. Instructions have also been issued to ensure responsible
lending conduct in terms of pricing and resetting pricing for loan related products, return of
loan related security documents, addressing customer grievances related to reporting of credit
scoring, etc.

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19. We have also addressed the issue of quick resolution of
customer grievances by regulated entities. Accordingly, the Reserve
Bank Integrated Ombudsman Scheme (RB-IOS) has been
introduced and implemented. This is a one-stop, cost-free touch point
for redressing customer grievances pertaining to certain key
segments of the Reserve Bank's regulated entitities. The scheme
envisages a grievance redress mechanism with powers to provide
personal hearing, compensation and an_ in-built appellate
mechanism. Importantly, the non-banking finance companies and
credit information companies have also been brought under the

ambit of the integrated ombudsman scheme, in addition to banks.

(d) Sustainable Finance Initiatives

20. Given the significant challenges from climate risks, a dedicated
Sustainable Finance Group has been institutionalized in the Reserve
Bank. Besides actively participating in dialogues with various
stakeholders at international and domestic levels, the focus has been
to kindle brainstorming among regulated entities to internally review
their systems, processes, policies and oversight towards sustainable

finance and the way forward.

(e) Measures to Develop Credit Market

21. In order to facilitate development of a robust market in credit
risk transfer and greater investor participation in stressed loans, the

Reserve Bank has put in place a regulatory framework in the form of

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guidelines on 'Securitisation of Standard Assets' and 'Transfer of
Loan Exposures' (2021). Subsequently, a Discussion Paper has
been issued on Framework for Securitizing Stressed Assets, the final
contours of which are now being formulated. A core group of major
banks has also been brought together to set up a self-regulatory body
- Secondary Loan Market Association (SLMA). This body will play a
major role in standardisation of documentation and market practices;
setting up of the market infrastructure; and promoting growth, liquidity
and efficiency of the secondary market in alignment with broad

regulatory objectives.

(f) Macro Prudential Measures

22. While we continue with our endeavour towards reorienting the
financial system, our focus on broader systemic stability and
addressing incipient signs of imprudent practices also continues.
Considering the persistent credit growth in certain segments of retail
credit, pre-emptive measures were announced in November 2023 to
sober down undue exuberance which was clearly visible. Risk
weights on certain segments of consumer credit have, therefore,
been enhanced. The issue of interconnectedness through bank
lending to NBFCs has also been addressed through higher risk
weights. More recently, concerns on ever-greening on account of
regulatory arbitrage between lenders and the alternative credit
channels - Alternative investment Funds (AIFs) - have similarly been
addressed (December 2023).

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Revamping the Reserve Bank's Supervisory Processes

23. Structural changes have also been implemented to enhance
the agility, flexibility, and specialisation of our supervisory structure.
The Reserve Bank's supervisory systems have been recalibrated to
attune them to the dynamics of the financial sector in a forward-
looking approach so as to smell possible distresses early. The
emphasis is on fostering resilience in the supervised entities (SEs) at
three levels - financial, operational and organisational. Needless to
say, it is a constantly evolving process, but it has been made more

dynamic. In this context, I propose to highlight five aspects.

(a) Unification of Regulatory and Supervisory arms

24. A unified and harmonized supervisory approach has been
institutionalised in the Reserve Bank for commercial banks, Non-
Banking Financial Companies (NBFCs) and urban cooperative banks
(UCBs). The emphasis is on identifying the root causes of
vulnerabilities using a wide array of supervisory tools. Earlier, three
separate units within the Reserve Bank were regulating and
supervising three different types of entities in the banking sector,
namely, the Scheduled Commercial Banks, the UCBs and the
NBFCs. Now, only one department of regulation (DOR) regulates,
while another department of supervision (DOS) supervises these
three segments. This unified and harmonized approach has led to
regulatory efficiency and effective oversight. It has enabled early and
timely detection of cross-linkages across the sectors as well as
synergy of regulatory and supervisory approaches. By no means,

however, we have adopted a one-size-fits-all model. The rationale

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was to bring in an activity-based supervisory approach in addition to

entity-based supervision.

(b) On-Site Supervision

25. The frequency and intensity of on-site supervisory engagement
is now based on the size as well as the riskiness of the institutions.
These supervisions have also become more intense and frequent.
We have strengthened our engagement with the senior management
and boards of the supervised entities. These are over and above the
interactions held with the supervised entities and their statutory
auditors by the Senior Supervisory Managers (SSMs). The focus is
now more on identifying the root cause of vulnerabilities, rather than
dealing with the symptoms alone. The priority areas are identified for
each supervisory cycle. The underlying objective binding all these
initiatives is to be proactive and ever vigilant in identifying and
addressing emerging risks and vulnerabilities. The recent (November
16, 2023) pre-emptive increase in the risk weights for consumer
credit and bank credit to NBFCs is an example of this approach. We
have also buttressed the feedback loop between onsite examination

and offsite analytics so as to have continuous supervision.

(c) Offsite Supervision: Sharper Analytics

26. We have considerably strengthened supervisory macro and
micro data analytics to capture potential and emerging risks. We

deep dive into the business models of banks and other lending

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entities and closely monitor their asset liability mismatches and
funding stability. We have a system of early warning signals that
provide lead indications of risk build-up. While asset quality and
capital position indicate resilience and robustness of financial
institutions in the medium term, recent experience in certain
advanced economies have shown that liquidity can become an
immediate cause of crisis. We monitor liquidity position of banks and
NBFCs very closely and aberrations, if any, are immediately taken
up with them for remedial measures. Stress tests are also carried out
on a continuous basis for both individual entities as well as at the
systemic level. Thematic studies across entities are also undertaken.
We do not interfere in the business decision making of regulated
entities, but our approach is to sensitise their senior management for
remedial action. In strengthening the offsite data analytics, models
have been developed with suitable and judicious use of machine
learning. The risk based supervisory rating models have been
revised on the basis of feedback from external and internal experts.
Thus, our whole approach to supervision is to be pro-active for

minimising surprises, spotting concerns and addressing them early.

(d) Sustained Focus on Capacity Building

27. As part of strengthening the Reserve Bank's supervision, a
College of Supervisors (CoS) for capacity building has been set up
in 2020. The College has joined the cohort of Global Institutions on
Financial Resilience. We have collaborated with many international

organisations such as the International Monetary Fund, the World

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Bank, the Bank for International Settlements, the Federal Reserve
Board, the Bank of England, the European Central Bank, the
Southeast Asian Central Banks and the Toronto Centre, with the
objective of having a platform for sharing experiences and building
global expertise. Through this process, the effort is to expand the

knowledge pool of our supervisors.

(e) Enhanced Focus on IT and Cybersecurity Risks

28. Another area of our close attention is the cybersecurity risk.
Although there are obvious benefits of adoption of IT in banking, the
attendant risks need to be effectively addressed. Considering the
diversification and complexity levels of our regulated and supervised
entities, we have issued differentiated cybersecurity baseline control
frameworks for the varied entities. For instance, a graded approach
for the co-operative banks has been implemented, depending upon
the digital services they offer. Guidelines have also been issued for
robust governance structures, minimum security standards, IT and
ITeS outsourcing, business continuity management, roles and

functions of Chief Information Security Officers, among others.

Conclusion

29. Inconclusion, I would like to say that the remarkable turnaround
in the Indian banking system has been the cornerstone of India's
success story in the recent years. Today, the Indian banking system

is well-placed to support India's growth story in the years ahead.

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30. Trust is the essence of a robust financial system and is built
over a period of time through sustained efforts. This needs to be
preserved. The Reserve Bank has committed itself to safeguard the
trust factor of the Indian financial system. Our recent efforts to
improve regulation and supervision are guided by this basic principle.
With our diverse responsibilities such as monetary authority,
regulator and supervisor of banks and non-banks, payment systems,
and other segments of the financial markets, we have used all our
instruments - monetary policy combined with macroprudential
regulation and supervision - synergistically to achieve better
outcomes. As we move forward, we guard against any sense of
complacency, and work tirelessly towards further strengthening
India's banking and financial system.

Thank you. Namaskar!

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