Structural Changes

1. Prudential norms in focus

RBI asks banks to stay wary of privately placed papers

The Reserve Bank of India (RBI) is set to tighten the prudential norms for banks investments in non-SLR (statutory liquidity ratio) securities, particularly those which are picked up through the private placement route.

In the monetary and credit policy announced on Monday, the RBI said the new norms will cover the strengthening of internal rating systems of banks, fixing of prudential limits, with separate sub-limits for unrated, unquoted and privately placed instruments, review by banks board on total investments and disinvestments and disclosures in 'Notes on Accounts' regarding issuer composition and non-performing investments among others.

 

The central bank is planning to prepare a set of draft guidelines on this which will be finalised only after consultation with the banks and financial institutions.

The RBI has also proposed to constitute a working group with representatives from banks as its members and the Credit Information Bureau (CIB) as its convenor. The group will evolve a framework for collecting and sharing information on the private placement of debt.

The new prudential guidelines will apply uniformly to all bonds issued by corporates, banks, FIs and state and central government-sponsored institutions directly or through special purpose vehicles (SPVs). The central bank also said that in case of bonds guaranteed explicitly or implicitly, banks should not be swayed entirely by the fact of the guarantee.

The RBI has advised banks and FIs to undertake due diligence on the intrinsic viability and bankability of projects being financed through the issuance of such bonds before making any investment decisions.

The RBI had already issued a set of guidelines in June 2001 regarding the due diligence to be undertaken, the disclosures to be obtained and the credit risk analysis to be made in regard to privately placed investments especially for unrated instruments. Banks are required to adopt an internal system of rating for issues made by non-borrowers (that, is where the bank does not have a relationship with the borrower), and adopt prudential limits to mitigate the adverse impact of concentration of instruments from one borrower group.

The RBI had advised banks to put in place proper risk management systems. But after all these measures, the apex bank has observed that there is possibility that the funds mobilised through the private placement route can be used for purposes other than what is disclosed in the offer document. And, it wants banks to upgrade their due diligence systems to avoid such a contingency.

2. Long-term repos on cards

LAF rates will continue to operate around the bank rate, with a flexible corridor around it, says the RBI

The Reserve Bank of India (RBI), in its mid-term review of monetary and credit policy for this fiscal, has reiterated its resolve to introduce long-term repos of up to 14-day periods as and when required.

The central bank said the liquidity adjustment facility (LAF) mechanism has been evolved as an efficient instrument for influencing liquidity in the market on a day-to-day basis.

It said the average daily absorption through the repo transactions under the LAF, till October 5 during the current fiscal, amounted to about Rs 3,600 crore.

The apex bank said: "The LAF has rendered the necessary flexibility to RBI to operate on liquidity and, to some extent, to signal interest rates in the short-term money market. The LAF operations, combined with strategic open market operations, have evolved into the principal operating procedure of monetary policy of the RBI in the short-run."

The central bank said LAF rates will continue to operate around the bank rate, with a flexible corridor around it.

In the last six months, the RBI has brought down the repo rate and reverse repo rates by 50 basis points each to 6.50 per cent and 8.50 per cent, respectively. With the bank rate cut by another 50 basis points, dealers are expecting both the rates to come down further.

The apex bank added that the efficiency of the LAF mechanism will be further improved as and when the call money market is converted to a pure interbank market.

The cap on the call money lending by the non-bank entities should not hamper the liquidity in the overnight market, the RBI said. Despite the cap, the average daily aggregate lending in the overnight market improved to Rs 19,600 crore during May-September in this year compared with Rs 10,900 crore during the corresponding period of the last year.

Effective May 2001, non-bank entities have been permitted to lend only up to 85 per cent of their average daily lending during 2000-01.

3. Satellite dealing set for shake-up

The Reserve Bank of India is set to review the satellite dealer (SD) system since their role in retailing of government securities has remained very limited. The review will consider the role carved out for SDs in the development of retail market, particularly in the context of the expanding role of primary dealers, the emerging alternative mechanism of retailing government securities on the screen-based exchanges, and the supervisory concerns in monitoring SDs' operations.

The satellite dealer system was introduced in 1996 to serve as a second tier to PDs in the government securities market with the particular objective of promoting retail segment. But after a gap of five years even as a complementary service, the SD system is perceived to result in higher transaction costs to retail investors, said the RBI. It also added, " Many of them being broking firms with limited capital strength and having wider presence in non-government securities business have also raised some supervisory concerns."

Among other measures pertaining to the government security market the central bank is drawing a road map for developing separate trading of registered Interest and principal of securities (STRIPS). The RBI also said that the negotiated dealing system (NDS) will make a test run in the November. The Clearing Corporation of India Limited (CCIL) which was registered on April 30, 2001 will commence with a test run in the same month.

The central bank has also finalised a scheme of retail participation, including the middle segment encompassing Provident Funds, trusts, etc., in the primary market for government securities on non-competitive basis.

Necessary amendments to notification issued by the government for introduction of uniform price auction format for auctions of dated securities are also being proposed. With the approval of the Government, the new auction format will be introduced on an experimental basis.

4. 'Universal banking is not the solution'

It cannot provide a viable or sustainable solution to the operational problems of banks and financial institutions

"Universal banking is not the panacea for the operational problems of banks and financial institutions (FIs)," said the RBI governor Bimal Jalan in the credit policy today.

He pointed out that universal banking, by itself, cannot provide a viable or sustainable solution to the operational problems of individual institutions arising from low capitalisation, high level of non-performing assets (NPAs), large asset-liability mismatches, and liquidity.

The governor said movement towards universal banking is expected to foster stability and efficiency of the financial system, implying that the current problems of some of the financial institutions may not be conducive to their migration into universal banks.

Welcoming the FIs' move towards universal banking, he said it intends to ensure healthy competition in the financial system through transparent and equitable regulatory framework applicable to all participants in the banking business.

But he cautioned about processing of applications and said the central bank will pay special attention to the safety of deposits, especially those of the small depositors. At the same time, the move will have to meet the strategic objectives of the financial institution concerned in satisfying the varied needs of different categories of customers.

Financial institutions, ICICI and IDBI, have mooted plans to become universal banks, principally driven by the desire to bring down the cost of the funds.

Acknowledging that the FIs just wanted to access cheap deposits, the RBI said the interests of the depositors will get primacy over all else.

The policy, however, stated that no proposals have been received to date, even as the salient operational and regulatory issues for FIs' conversion into universal banks was communicated on April 28, 2001.

FIs had asked for exemptions from priority-sector lending obligations, which stand at 40 per cent of overall advances for banks as also a lower CRR and SLR stipulation, at least in the initial stages.

The governor expressed concerns over the financial institutions not being able to meet the key objectives. Also, the additional SLR, CRR and priority-sector lending stipulations would further impair their weak balance sheets, he said.

Similarly, the movement towards universal banking does not, in any way, ensure the decline in FIs' non-performing assets.

In the circumstances where the move towards universal banking does not change any of the financial parameters of the institutions, the governor questioned the rationale of these institutions' moving into retailing deposits.

"As they are keen to capture cheaper cost of funds through savings and demand deposits, they might also end up creating an asset-liability mismatch," the policy said.