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CAIIB Paper 4 BRBL Module A Unit 7 : Financial Sector Legislative Reforms & Financial Stability And Development Council (New Syllabus)
IIBF has released the New Syllabus Exam Pattern for CAIIB Exam 2023. Following the format of the current exam, CAIIB 2023 will have now four papers. The CAIIB Paper 4 (BANKING REGULATIONS AND BUSINESS LAWS) includes an important topic called “Financial Sector Legislative Reforms & Financial Stability And Development Council”. Every candidate who are appearing for the CAIIB Certification Examination 2023 must understand each unit included in the syllabus.
In this article, we are going to cover all the necessary details of CAIIB Paper 4 (BRBL) Module A (REGULATIONS AND COMPLIANCE) Unit 7 : Financial Sector Legislative Reforms & Financial Stability And Development Council, Aspirants must go through this article to better understand the topic, Financial Sector Legislative Reforms & Financial Stability And Development Council and practice using our Online Mock Test Series to strengthen their knowledge of Financial Sector Legislative Reforms & Financial Stability And Development Council. Unit 7 : Financial Sector Legislative Reforms & Financial Stability And Development Council
Narasimham Committee 1 (1991)
- The Committee was set up in August 1991, to examine all aspects relating to the ‘Structure, Organization, Functions and Procedures’ of the financial system. It was also called the ‘Committee on Financial Systems’.
- High CRR & SLR: The Committee found that the CRR and SLR required to be kept by Banks was very high (aggregating to 53.5% at that time) that led to a continuous loss in potential income to banks, which in turn adversely affected their profitability. The Committee termed the high SLR/SLR as a ‘Tax on the Banking System’ and recommended its lowering.
- Directed Credit Program: The Committee was generally critical of the directed lending to priority sector and felt that this resulted in overlooking of the qualitative aspects of credit and deterioration in the quality of the loan portfolio besides no proper appraisal of credit applications, no insistence on collateral and very weak post credit supervision and monitoring.
- Interest subsidy: The Committee was of the view that interest subsidy being offered in various schemes, especially government sponsored ones, was loss of precious profits for the Banks and that timely credit was more important than this charging of subsidized interest.
- Other findings: The Committee also brought to focus the other factors plaguing the PSBs some of which have been brought out below –
- Opening of large number of branches without considering in many cases need and potential viability.
- The lines of command and control had stretched too far and central office supervision, internal inspection and audit weakened.
- Deterioration in staff quality due to rapid recruitment and promotion without proper training and experience.
- Excessive bank credit to agriculture and small industry, where the unit cost of administering the loans tend to be high, increasing staff requirements/ staff costs and impacting profitability.
Narasimham Committee 2 (1998)
The Narasimham Committee 2 was termed “Committee on Banking Sector Reforms” and set up in December 1997 to review the progress of implementation of financial sector reforms recommended by the Committee on Financial Systems (CFS) (1991).
The major recommendations of the Committee were those regarding
- Strengthening of the ‘Banking System’ in India (Capital Adequacy measures/concept of Risk Weights)
- Introduction of stringent ‘Asset Quality’ norm
- Interest subsidy for priority sector to be eliminate
- Introduced concept of Asset Reconstruction Companies (ARCs) etc.
- Need for strict implementation of IRAC norms and Disclosure requirements, changes in systems and procedures etc.
Banking Sector Reforms
Competition enhancing measures
- Granting of operational autonomy to public sector banks, reduction of public ownership in public sector banks by allowing them to raise capital from equity market up to 49 per cent of paid-up capital.
- Transparent norms for entry of Indian private sector, foreign and joint-venture banks and insurance companies, permission for foreign investment in the financial sector in the form of Foreign Direct Investment (FDI) as well as portfolio investment.
- Roadmap for presence of foreign banks and guidelines for mergers and amalgamation of private sector banks and NBFCs.
- Foreign banks being permitted to operate in India through any one of three channels.
- Licensing of banks in the private sector/part divestment in PSBs: The RBI has also more recently given an impetus and encouraged setting up for differentiated banks/small finance banks etc.
- After nationalization of 14 large banks in 1969 and the onset of globalization and liberalization in 1991, it was recognized that there is urgent need for introducing greater competition in the Indian money market which could lead to higher efficiency of the financial system.
- Migration to CBS
- Introducing VRS (year 2001), etc.
Resultantly by the year 2008, banks’ balance sheets were much stronger/growth was strong/ NPAs had come down from the peak of around 12% to slightly over 2%.
Measures enhancing role of market forces
- Market determined pricing for government securities, disbanding of administered interest rates.
- Introduction of pure inter-bank call money market, auction-based repos, reverse-repos for short term liquidity management, facilitation of improved payments and settlement mechanism.
- Significant advancement in dematerialization and markets for securitized assets.
- More recent RBI introduction of the ‘Targeted Long Term Repo Operations Scheme’ whereby Banks are allowed to borrow, on tap, at Repo Rates for periods up to 3 years for investing in specific assets/sectors, thereby infusing liquidity in the market.
- The Statutory Liquidity Ratio (SLR) which was 38.5 per cent in 1991-1992 was brought down to some 28 per cent in five years. Similarly, the CRR brought down from 14 per cent to 10 per cent by 1997. This has been further reduced to SLR -18% and CRR 4.50% currently (November 2022). The Capital to Risk Weighted Assets Ratio (CRAR) of scheduled commercial banks (SCBs), introduced in 1992, stood at 14.2 per cent as of March 2019 remained well above the regulatory requirement of 9.0%
- Measures to strengthen risk management through recognition of different components of risk, assignment of risk-weights to various asset classes and connected norms.
- Lending, risk concentration, application of marked-to-market principle for investment portfolio and limits on deployment of fund in sensitive activities started.
- ‘Know Your Customer’ and ‘Anti Money Laundering’ guidelines, introduction of Basel II/III guidelines, introduction of capital charge for market risk, higher graded provisioning for NPAs.
- The RBI introduced, in a phased manner, prudential norms for income recognition, asset classification and provisioning for the advances portfolio of the banks so as to move towards greater consistency and transparency in the published accounts.
- Deregulation of credit processes and interest rate structures: The structure of administered rates have been almost totally done away with in a phased manner under reform
Institutional and legal measures
- Setting up of Lok Adalats (people’s courts), debt recovery tribunals, asset reconstruction companies, settlement advisory committees, etc. for quicker recovery/ restructuring.
- Promulgation of Securitization and Reconstruction of Financial Assets and Enforcement of Securities Interest (SARFAESI) Act, 2002
- Setting up of Credit Information Bureau of India Limited (CIBIL) for information sharing on defaulters as also other borrowers.
- Setting up of Clearing Corporation of India Limited (CCIL) to act as central counter party for facilitating payments and settlement system.
- Enacted the Insolvency and Bankruptcy Code in 2016 to amend the laws relating to reorganization and insolvency resolution of corporate persons, partnership firms and individuals in a time bound manner.
- Establishment of the Board for Financial Supervision as the apex supervisory authority for commercial banks, financial institutions and NBFCs.
- Introduction of CAMELS supervisory rating system, move towards risk-based supervision.
- Strengthening corporate governance, enhanced due diligence on important shareholders, fit and proper tests for directors, etc. introduced.
- The Government of India introduced the ‘Enhanced Access & Service Excellence’.1 (EASE) in January 2018 which represented a comprehensive reforms agenda required to be put in place in a time bound manner by PSBs thereby institutionalizing clean and smart banking.
Technology Related measures
- Setting up of INFINET as the communication backbone for the financial sector, introduction of Negotiated Dealing System (NDS) for screen-based trading in government securities
- Promulgation of Payment & Settlement System Act, 2007
- Introduction of RTGS, NEFT, ECS, ATMs, Mobile Banking, Internet Banking, E-commerce, “Immediate Payment Service (IMPS), Unified Payments Interface (UPI), etc.
- Many Banks, have since 2020, also embraced enthusiastically the use of new age technologies such as Artificial Intelligence, Machine Learning, Robotics and Digital Banking.
- Banks are also increasingly getting into tie ups with Fintech companies to expedite their digital transformation.
- The use of blockchain technology/AI /ML etc.
Reforms In Monetary Policy
- Emphasis has been put on development of multiple instruments to transmit liquidity and interest rate signals in the short-term in a flexible and bi-directional manner.
- Move from direct instruments (such as, administered interest rates, reserve requirements, selective credit control) to indirect instruments (such as, open market operations, purchase and repurchase of government securities) for the conduct of monetary policy.
- LAF has emerged as the tool for both liquidity management and also as a signaling devise for interest rate in the overnight market. RBI has introduced Standing Deposit facility (SDF) which is the floor limit of the Policy corridor.
- Use of open market operations (OMO) to deal with overall market liquidity situation especially those emanating from capital flows; Introduction of Market Stabilization Scheme (MSS) as an additional instrument to deal with enduring capital inflows without affecting short-term liquidity management role of LAF, etc.
Reforms In Financial Markets
- Repos/CBLO: With steps towards making call market a pure inter-bank market, turnover progressively switched from call money market to repo and CBLO market as daily average volumes in call market got Substantially reduced. Volumes in case of market repo and CBLO, on the other hand, rose manifold.
- Government Securities Market: As a part of reforms, concessionary financing was eliminated with introduction of market auction system and phasing out of automatic monetisation with Ways and Means Advances (WMA).
- Capital Market: Primary market witnessed a significant movement away from Controller of Capital Issues (CCI) regime imposing primary issuance at sub-market rates to free pricing and book-building system along with mandatory disclosures as prescribed by SEBI. In the secondary market, corporatization of exchanges, screen-based trading replacing open outcry system, introduction of options and futures replacing erstwhile Badla System.
Financial Sector Development Council
- Financial Sector Development Council (FSDC) was constituted in Dec. 2010.
- The primary objective of FSDC is to strengthen and institutionalize the mechanism for maintaining financial stability, promoting financial sector development and enhancing internal regulatory co-ordination. There should be coordination among these financial sector regulators to ensure better efficiency as well as for avoiding overlapping of functions.
- Government of India set up Financial Stability and Development Council (FSDC) in December 2010 with the Finance Minister as the Chairman. It is not a statutory body.
Composition of FSDC
The Chairman of the Council is the Finance Minister and its members include:
- Heads of financial sector Regulators (RBI, SEBI, IRDAI, & PFRDA)
- Finance Secretary and/or Secretary
- Secretaries from Department of Economic Affairs (DEA), Department of Financial Services (DFS), Revenue Department and Ministry of Information Technology (MeitY)
- Chairman of the Insolvency and Bankruptcy Board of India (IBBI)
- Chief Economic Adviser.
Function Of The FSDC
The functions of FSDC include:
- To strengthen and institutionalize the mechanism for maintaining financial stability and development;
- Monitoring of macro-prudential supervision of the economy including the functions of large financial conglomerates;
- To enhance inter-regulatory coordination;
- Focus on financial literacy and financial inclusion.
Wings of FSDC
- FSDC Sub-Committee: An important wing of the FSDC is the Sub-committee chaired by the Governor of the RBI. All the members of the FSDC are also the members of the Sub-committee. Additionally, all four Deputy Governors of the RBI and Additional Secretary, DEA, in charge of FSDC, are also members of the Sub Committee.
- Inter regulatory technical group (IR – TG): A technical group was set up in September 2011 for inter-regulatory coordination among the financial sector regulators. This is headed by ED in charge of Financial Stability, RBI. The Group discusses issues relating to risks to systemic financial stability and inter-regulatory coordination and provides inputs to the Subcommittee.
- Inter Regulatory Forum for monitoring Financial Conglomerates (IRF-FC): 2012). The IRF-FC is headed by the Deputy Governor, RBI.
- Working Group on resolution regime for financial institutions: The mandate of the Group is to examine the existing resolution regime/ framework for the entire financial sector and identify gaps in the national resolution regime/ framework.
- Macro Financial Monitoring Group (MFMG): It chaired the Chief Economic Adviser. The Group discusses the macro financial situation essentially based on the information obtained from various “anchor divisions” on important macroeconomic and financial variables.
- Early Warning Group: A Group was set up by the FSDC Sub-committee in June 2012 to coordinate the response of GoI/Regulators in the time of a crisis situation. It is chaired by DG, RBI, in-charge of Financial Markets Department.