Deputy Governor of the Reserve Bank of India Usha Thorat summarised the Indian financial services regulatory scenario. He said that its financial system was not seriously affected by the crisis mainly because of the low integration of the domestic financial sector with the global financial system.
Usha Thorat’s presentation was divided into the following four sections:
· Key factors which contributed to the current global financial crisis
· A brief account of the international regulatory response
· Indian banking and regulatory scenario – both pre- and post-crisis, including the recent regulatory initiatives
· The emerging challenges in banking regulation as India aspires for higher growth
India’s financial system, like most emerging market economies, was not seriously affected by the financial turmoil in the developed economies mainly because of the relatively lower integration of the domestic financial sector with the global financial system, and limited exposure of overseas branches of Indian banks to the synthetic and complex structured products. The adverse effects on the economy were mainly due to sudden reversal of capital flows, tightening of credit availability from the overseas and domestic markets impacting respectively on the domestic Forex market and liquidity conditions. This resulted in increased pressure on banks to provide credit at a time when their financial resources were already quite strained pursuant to the rapid credit expansion in the previous three years. In the circumstances, the thrust of the various policy initiatives by the Reserve Bank has been on providing ample rupee liquidity, ensuring comfortable dollar liquidity and maintaining a market environment conducive for the continued flow of credit to productive sectors.
Capital requirements
The minimum capital adequacy ratio (CRAR) for banks in India at nine per cent is higher than the Basel norm of eight per cent. Banks are also required to ensure minimum Tier I capital ratio of six per cent from April 1, 2010. The current average CRAR for the scheduled commercial banks is over 13 per cent while Tier I ratio is about nine per cent. Importantly, Tier I capital does not include items such as intangible assets and deferred tax assets that are now sought to be deducted internationally.
Derivatives
In December 2002, banks’ exposure to derivatives was brought under the capital adequacy regime by prescribing credit conversion factors linked to the maturities of interest rate contracts and exchange rate contracts. Accordingly, since April 1 2003, banks have been advised to adopt, either original exposure method based on original maturity or current exposure method based on residual maturity, consistently for all derivative products, in determining individual/group borrower exposure. After the banks gained sufficient expertise in the area, the option of original exposure method was withdrawn and since August 2008 banks have been required to compute their credit exposures, arising from the interest rate and foreign exchange derivative transactions using the current exposure method. The conversion factors were increased and doubled for certain residual maturities with a view to improve the capital cushion available for such derivative products.
The amendments to Reserve Bank of India Act, 1934 in 2006 conferred on the RBI explicit powers to regulate the derivative products which have the exchange rate, interest rate or credit rating as the underlying. Comprehensive guidelines on derivatives were issued in April 2007. The guidelines, intended to safeguard the interests of the system as well as the players in the market, lay down eligibility criteria, broad principles for undertaking derivative transactions, permissible derivative instruments, risk management and corporate governance aspects as also aspects relating to both suitability and appropriateness of a derivative product for a client.
Compensation of CEOs
The Reserve Bank has been mandated by statute to regulate executive compensation in private sector banks. It is the statutory responsibility of RBI to ensure that the remunerations of bank CEOs and whole-time directors are not excessive. In terms of Section 35 B of the Banking Regulation Act, 1949, banks in the private sector and foreign banks in India are required to obtain the approval of the Reserve Bank for remuneration payable to their CEOs, while the remuneration of public sector bank CEOs is fixed by the Government of India.
The RBI ensures that executive compensation, whether it is in the form of cash or stock, is appropriate, taking into account the financial position of the concerned bank and also industry practice. The RBI has instructed the boards of private sector banks to fix the remuneration package of CEOs at a reasonable level in light of industry practice in India. Further, the annual bonuses of private sector bank CEos are capped at a certain percentage of their base salary. The Remuneration Committees of banks, consisting of independent directors, are made responsible for implementating compensation structure in banks.
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