Monetary Policy statement 2011-12

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Monetary Policy statement 2011-12 Powered By Docstoc
					            ReseRve Bank Of IndIa

      Monetary Policy statement

(Including developmental and Regulatory Policies)

               dr. d. subbarao

                  May 3, 2011

                                                                                                    Page no.

Part A. Monetary Policy

    I.     The State of the Economy ........................................................................ 2

    II.    Outlook and Projections ........................................................................... 6

    III. The Policy Stance ................................................................................... 10

    IV. Monetary Measures .................................................................................11

Part B. Developmental and Regulatory Policies

    I.     Financial Stability .................................................................................. 14

    II.    Interest Rate Policy ................................................................................ 15

    III. Financial Markets ................................................................................... 15

    IV. Credit Delivery and Financial Inclusion ................................................ 17

    V.     Regulatory and Supervisory Measures for Commercial Banks ............. 21

    VI. Institutional Developments .................................................................... 26
AACS     -    As Applicable to Co-operative Societies
AD       -    Authorised Dealer
AMA      -    Advanced Measurement Approach
ASA      -    Alternate Standardised Approach
ATM      -    Automated Teller Machine
BC       -    Business Correspondent
BCBS     -    Basel Committee on Banking Supervision
BPLR     -    Benchmark Prime Lending Rate
CAD	     -	   Current	Account	Deficit
CBLO     -    Collateralised Borrowing and Lending Obligation
CBS      -    Core Banking Solution
CCIL     -    Clearing Corporation of India Limited
CDs	     -	   Certificates	of	Deposit
CDS      -    Credit Default Swap
CERSAI   -    Central Registry of Securitisation Asset Reconstruction and
              Security Interest of India
CI	      -	   Confidence	Interval
CMD      -    Chairman and Managing Director
CPI      -    Consumer Price Index
CRR      -    Cash Reserve Ratio
CSPs     -    Customer Service Providers
CSGL     -    Constituent Subsidiary General Ledger
DCCBs    -    District Central Co-operative Banks
DoMFs    -    Debt Oriented Mutual Funds
DvP      -    Delivery versus Payment
ECS      -    Electronic Clearing Service
EMEs     -    Emerging Market Economies
FAO      -    Food and Agriculture Organisation
FDI      -    Foreign Direct Investment
FEMA     -    Foreign Exchange Management Act
FII       -   Foreign Institutional Investor
FIP       -   Financial Inclusion Plan
FSB       -   Financial Stability Board
FSR       -   Financial Stability Report
FSS       -   Farmers Service Societies
GCC       -   General Credit Card
GDP       -   Gross Domestic Product
G-20      -   Group of Twenty
IASB      -   International Accounting Standard Board
IBA       -   Indian Banks' Association
ICT       -   Information and Communication Technology
IDRBT     -   Institute for Development and Research in
              Banking Technology
IFRSs     -   International Financial Reporting Standards
IIP       -   Index of Industrial Production
IMA       -   Internal Models Approach
IMD       -   India Meteorological Department
IMF       -   International Monetary Fund
IND AS    -   Indian Accounting Standards
INFINET   -   Indian Financial Network
IOS       -   Industrial Outlook Survey
IRB       -   Internal Rating Based
IRFs      -   Interest Rate Futures
ISO       -   International Organisation for Standardisation
IT        -   Information Technology
JLG       -   Joint Liability Group
KCC       -   Kisan Credit Card
LAF       -   Liquidity Adjustment Facility
LAMPS     -   Large Adivasi Multi-purpose Co-operative Societies
M3        -   Broad Money
MENA      -   Middle East and North Africa
MFIs      -   Micro Finance Institutions
MIS        -    Management Information System
MoU        -    Memorandum of Understanding
MSF        -    Marginal Standing Facility
MSEs       -    Micro and Small Enterprises
MSMEs      -    Micro, Small and Medium Enterprises
NABARD     -    National Bank for Agriculture and Rural Development
NBFCs      -    Non-Banking Financial Companies
NDS        -    Negotiated Dealing System
NDTL       -    Net Demand and Time Liabilities
NEFT       -    National Electronic Funds Transfer
NG-RTGS    -    Next Generation Real Time Gross Settlement
NRIs       -    Non-resident Indians
OBICUS     -    Order Books, Inventories and Capacity Utilisation Survey
OMO        -    Open Market Operation
OTC        -    Over-the-Counter
PACS       -    Primary Agricultural Credit Societies
PCR        -    Provisioning Coverage Ratio
PIN	       -	   Personal	Identification	Number
PIOs       -    Persons of Indian Origin
PMI        -    Purchasing Managers’ Index
PoS        -    Points of Sale
PSBs       -    Public Sector Banks
Q          -    Quarterly
RBI        -    Reserve Bank of India
REER       -    Real Effective Exchange Rate
RRBs       -    Regional Rural Banks
RTGS       -    Real Time Gross Settlement
SARFAESI   -    Securitisation and Reconstruction of Financial Assets
                and Enforcement of Security Interest
SCBs       -    Scheduled Commercial Banks
SEBI       -    Securities and Exchange Board of India
SGL        -    Subsidiary General Ledger
SHG     -   Self-Help Group
SLAF    -   Second LAF
SLR     -   Statutory Liquidity Ratio
StCBs   -   State Co-operative Banks
TSA     -   The Standardised Approach
UCBs    -   Urban Co-operative Banks
US      -   United States of America
WEO     -   World Economic Outlook
WOS     -   Wholly Owned Subsidiary
WPI     -   Wholesale Price Index
XML     -   Extensible Mark up Language
Y-o-Y   -   Year-on-Year

                             Reserve Bank of India
                        Monetary Policy statement 2011-12

                                       Dr. D. subbarao

Introduction                                             pass-through of input price increases.
         The Annual Policy for 2011-12 is                Significantly,	this	is	happening	even	as	there	
                                                         are visible signs of moderating growth,
set	in	conditions	significantly	different	than	
                                                         particularly in capital goods production
they were a year ago. Last year’s policy
                                                         and investment spending, suggesting that
was made in an environment of incipient
                                                         cumulative monetary actions are beginning
domestic recovery amidst uncertainty about
                                                         to have an impact on demand.
the state of the global economy, a perception
that was reinforced with the precipitation               3.       Thus, three factors have shaped the
of the Greek sovereign debt crisis a few                 outlook and monetary strategy for 2011-12.
weeks	 later.	 While	 signs	 of	 inflation	 were	        First, global commodity prices, which have
visible, they were driven primarily by food.             surged in recent months, are likely to, at best,
However, food price pressure spilling over               remain	firm	and	may	well	increase	further	
into	more	generalised	inflation	was	clearly	             over the course of the year. Second, headline
a risk as the recovery consolidated and                  and	core	inflation	have	significantly	overshot	
domestic resource utilisation rose to levels             even the most pessimistic projections over
which stretched capacities. Throughout the               the past few months. In terms of the likely
year, the goal of monetary policy was to                 trajectory	of	inflation	over	the	year,	the	first	
nurture the recovery in the face of persistent           suggests	that	high	inflation	will	persist	and	
global uncertainty while trying to contain               may get worse. The second raises concerns
the	spillover	of	supply-side	inflation.                  about	 inflationary	 expectations	 becoming	
2.	      The	 trend	 of	 moderating	 inflation	
and consolidating growth in the second                   4.      The third factor, countering these
and	 third	 quarters	 of	 2010-11	 justified	 the	       forces, is the likely moderation in demand,
calibrated policy approach of the Reserve                which should help reduce pricing power and
Bank.	However,	the	resurgence	of	inflation	              the extent of pass-through of commodity
in the last quarter of 2010-11 was a matter of           prices. This cannot be ignored in the policy
concern. Although the trigger was the sharp              calculation.	 However,	 a	 significant	 factor	
uptrend in international commodity prices,               influencing	 aggregate	 demand	 during	 the	
the fact that these were quickly passing                 year	 will	 be	 the	 fiscal	 situation.	 While	
through into the entire range of domestic                the budget estimates offered reassurance
manufactured goods indicated that pricing                of a rollback, the critical assumption that
power	is	significant.	In	other	words,	demand	            petroleum and fertiliser subsidies would
has	been	strong	enough	to	allow	significant	             be capped is bound to be seriously tested

at prevailing crude oil prices. Even though               II sets out the outlook and projections for
adjustment of administered retail prices may              growth,	inflation	and	monetary	aggregates.	
add	to	inflation	in	the	short	run,	the	Reserve	           Section III explains the stance of monetary
Bank believes that this needs to be done as               policy.	 Section	 IV	 specifies	 the	 monetary	
soon as possible. Otherwise, the consequent               and liquidity measures, including the
increase	in	the	fiscal	deficit	will	counter	the	          modified	 operating	 procedures	 in	 the	 light	
moderating trend in aggregate demand.                     of the recommendations of the Working
5.       The monetary policy trajectory that              Group on Operating Procedure of Monetary
is being initiated in this Annual Statement               Policy (Chairman: Shri Deepak Mohanty)
is based on the following premise. Over                   and the feedback received thereon.
the	 long	 run,	 high	 inflation	 is	 inimical	 to	
                                                          7.      Part B covers Developmental and
sustained growth as it harms investment by
                                                          Regulatory Policies and is divided into six
creating uncertainty. Current elevated rates
                                                          sections: Financial Stability (Section I),
of	 inflation	 pose	significant	 risks	 to	 future	
                                                          Interest Rate Policy (Section II), Financial
growth. Bringing them down, therefore,
even at the cost of some growth in the                    Markets (Section III), Credit Delivery and
short-run, should take precedence.                        Financial Inclusion (Section IV), Regulatory
                                                          and Supervisory Measures for Commercial
6.      Against this backdrop, this                       Banks (Section V) and Institutional
Statement sets out the Reserve Bank’s                     Developments (Section VI).
assessment of the current macroeconomic
situation and projections. It is organised in             8.      Part A of this Statement should
two parts. Part A covers Monetary Policy                  be read and understood together with the
and is divided into four Sections. Section I              detailed review in Macroeconomic and
provides an overview of global and domestic               Monetary Developments released yesterday
macroeconomic developments. Section                       by the Reserve Bank.

                                  Part A. Monetary Policy
                                 I. the state of the economy
Global economy                                            2011, moderated in March 2011 on the back
                                                          of higher oil prices.
9.       The global economy during the
first	 quater	 of	 2011	 continued	 with	 the	            10.     GDP growth in the US, which was
momentum of late 2010. The global                         strong at 3.1 per cent (q-o-q seasonally
manufacturing purchasing managers’ index                  adjusted annualised rate) in Q4 of 2010,
(PMI) for February 2011 was close to a                    slipped	 to	 1.8	 per	 cent	 reflecting	 a	 decline	
record high, while the global services PMI                in government spending, deceleration in
recorded its fastest pace of expansion in                 private consumption and increase in imports.
almost	 five	 years.	 Although	 these	 indices	           Clearly, a number of weaknesses persist.
slipped somewhat in March 2011, they                      The US housing market remains weak. More
signalled continuing expansion. However,                  generally, unemployment rates continue
consumer	 confidence	 in	 major	 countries,	              to remain elevated in major advanced
which improved during January-February                    economies, albeit with some improvement

in the US. Concerns about sovereign debt in          a	 direct	 impact	 on	 inflation	 in	 advanced	
the euro area have now been reinforced by            economies, despite substantial negative
developments in the US. Finally, and most            output gaps. They have also accentuated
importantly, commodity price increases               inflationary	 pressures	 in	 EMEs,	 which	
have accelerated, engendering global                 were already experiencing strong revival
inflationary	fears	and	posing	downside	risks	        in demand. While major EMEs have been
to growth.                                           tightening monetary policies for more than
                                                     a year now, the European Central Bank
11.      The Brent crude price surged
                                                     has	recently	raised	its	policy	rate	-	the	first	
from an average of US$ 75 a barrel during
                                                     central bank to do so among the major
May-September 2010 to US$ 123 a barrel
                                                     advanced economies - after maintaining
by April 2011. The International Monetary
                                                     them at historically low levels for almost
Fund's (IMF) in its April 2011 World                 two years. Central banks in other advanced
Economic Outlook (WEO) has assumed                   economies are also under pressure to
US$ 107 a barrel for the full year 2011.             withdraw monetary accommodation. The
Initially, oil prices were buoyed by strong          above trend poses appreciable downside
global demand and excessive liquidity.               risks to global economic activity.
Since February 2011, oil prices have come
under further pressure on account of                 Domestic economy
apprehensions about supply disruptions
due to political developments in the Middle          14.     The Indian economy is estimated
East and North African (MENA) region.                to have grown by 8.6 per cent during
The demand for oil is expected to increase           2010-11. Agricultural growth was above
with the possibility of Japan substituting           trend, following a good monsoon. The
some of its shut-in nuclear power capacity           index of industrial production (IIP), which
with oil-based generation, combined with             grew	by	10.4	per	cent	during	the	first	half	of	
higher energy usage once reconstruction              2010-11, moderated subsequently, bringing
gets underway.                                       down the overall growth for April-February
                                                     2010-11 to 7.8 per cent. The main contributor
12.     In the recent period, commodity              to this decline was a deceleration in the
prices have been under pressure due to               capital goods sector. However, other
strong demand from emerging market                   indicators, such as the manufacturing
economies	(EMEs)	and	the	financialisation	           PMI, tax collections, corporate sales and
of commodity markets. Global consumption             earnings growth, credit off-take by industry
of most base metals is estimated to have             (other than infrastructure) and export
reached new highs in 2010. According to              performance, suggested that economic
the Food and Agriculture Organisation                activity was strong.
(FAO), international food prices rose by
                                                     15.     According to the Reserve Bank’s
37	per	cent	(y-o-y)	in	March	2011,	reflecting	
                                                     Order Books, Inventories and Capacity
both higher demand and weather related
                                                     Utilisation Survey (OBICUS), the order
supply disruptions. The increase in global
                                                     books of manufacturing companies grew
food prices was led by the prices of cereals
                                                     by 7 per cent in October-December 2010 as
(60 per cent), edible oils (49 per cent) and
                                                     against 9 per cent in the previous quarter
sugar (41 per cent).
                                                     indicating sustained demand albeit with
13.     Commodity prices are now exerting            some moderation. The Reserve Bank’s

forward looking Industrial Outlook Survey              March 2011 from 13.3-15.0 per cent in
(IOS) shows a decline in the business                  April     2010.      Over        the    same
expectations index for January-March 2011              period,	   WPI	       inflation	     remained	
after two quarters of increase.                        elevated	    reflecting	     increases	     in	
                                                       non-food primary articles prices and
16.     Leading indicators of services sector
                                                       importantly, non-food manufactured product
suggest continuing growth momentum.
                                                       prices. This led to a broad convergence
Credit to the services sector grew by 24
                                                       of	 WPI	 and	 CPI	 inflation	 by	 the	 end	 of	
per cent in 2010-11 as compared with 12.5
per cent in the previous year. Other indicators
such as commercial vehicles production                 19.     Broad money supply (M3) growth at
and foreign tourist arrivals also showed an            15.9 per cent (year-on-year) during 2010-11
acceleration. However, the services PMI for            was lower than the Reserve Bank’s indicative
March 2011 showed some moderation as                   trajectory of 17 per cent due to slow deposit
compared with the previous month.                      growth and acceleration in currency
                                                       growth. The higher currency demand
17.	    Inflation	 was	 the	 primary	
                                                       slowed the money multiplier. Consequently,
macroeconomic          concern     throughout
                                                       M3	 growth	 slowed	 despite	 a	 significant	
2010-11. It was driven by a combination
                                                       increase in reserve money. This suggests
of factors, both structural and transitory.            that money supply growth was not a
Based	 on	 drivers	 of	 inflation,	 the	 year	         contributing	factor	to	inflation.
2010-11 can be broadly divided into three
periods.	In	the	first	period	from	April	to	July	       20.     Non-food credit growth, which had
2010, the increase in wholesale price index            been trending upwards from the beginning
(WPI) by 3.5 per cent was driven largely by            of the year, reached an intra-year high of
food items and the fuel and power group,               24.2 per cent (year-on-year) in December
which together contributed more than 60                2010. It slowed down subsequently to
per cent of the increase in WPI. During the            21.2 per cent by March 2011, which was
second period from August to November                  marginally higher than the Reserve Bank’s
2010, while WPI showed a lower increase                indicative projection of 20 per cent.
of 1.8 per cent, more than 70 per cent of              21.      The Reserve Bank’s estimates show
the increase was contributed by food and               that	the	total	flow	of	financial	resources	from	
non-food primary articles and minerals.                banks, domestic non-bank and external
In the third period from December 2010                 sources to the commercial sector during
to March 2011, WPI increased sharply by                2010-11, at `12,00,000 crore, was 12.3 per
3.4 per cent, driven mainly by fuel and                cent higher than that in the previous year.
power group and non-food manufactured                  There was a decline in non-bank sources
products, which together contributed over              of funds in 2010-11 as compared with
80 per cent of the increase in WPI. Thus,              that in the previous year. The decline was
the	inflationary	pressures,	which	emanated	            particularly noticeable in foreign direct
from food, clearly became generalised as               investment. However, this was more than
the year progressed.                                   offset	by	the	higher	flow	of	funds	from	the	
18.	    As	 food	 price	 inflation	 moderated,	        banking sector.
consumer price index (CPI) measures of                 22.    Data on sectoral deployment of
inflation	 declined	 to	 8.8-9.1	 per	 cent	 in	       bank	 credit	 show	 significant	 increases	 in	

credit	flow	to	industry	and	services.	Within	         outpacing deposit growth contributed to tight
industry, credit growth to infrastructure             liquidity conditions. Although a systemic
was	 robust.	 Credit	 flows	 improved	 in	            liquidity	 deficit	 was	 consistent	 with	 the	
respect of metals, textiles, engineering, food        anti-inflationary	stance	of	monetary	policy,	
processing, and gems and jewellery, among             the extent of tightness since October 2010
others. Within services, credit growth                was outside the comfort level of (+)/(-) one
accelerated to commercial real estate and             per cent of net demand and time liabilities
non-banking	financial	companies.	Housing	             (NDTL) of SCBs.
and vehicle loans recovered in 2010-11.
                                                      25.     The Reserve Bank initiated several
23.     The Base Rate system replaced the             measures to ease the liquidity situation.
Benchmark Prime Lending Rate (BPLR)                   These were: (i) additional liquidity support
system with effect from July 1, 2010. Major           under the liquidity adjustment facility
scheduled commercial banks (SCBs),                    (LAF) to SCBs up to one per cent of their
constituting about 81 per cent of total banking       NDTL by temporary waiver of penal
business, raised their Base Rates by 50-165           interest for any shortfall in maintenance of
basis points between October 2010 and                 statutory liquidity ratio (SLR) - for a brief
March 2011. Base Rates of 64 major banks              period the limit was two per cent of NDTL,
with a share of around 98 per cent in                 which was reduced to one per cent following
the total bank credit were in the range of            the permanent reduction in the SLR;
8.00-9.50	per	cent	(March	2011),	reflecting	          (ii) reduction in the SLR by one per cent;
greater convergence in Base Rates                     (iii) conducting open market operations;
announced by major banks. The weighted                and (iv) conducting the second LAF (SLAF)
average lending rate in the banking system            on a daily basis.
was 10.5 per cent as at end-March 2010.
Data from select banks indicate that the              26.     Liquidity conditions have eased
weighted average yield on advances,                   significantly	 in	 recent	 weeks,	 following	
which is a proxy measure for effective                a sharp reduction in government cash
lending rates, is projected to increase from          balances and moderation in the credit-
9.7 per cent in 2010-11 to 10.3 per cent in           deposit ratio of banks. Consequently, net
2011-12. This suggests that the Base Rate             liquidity injected by the Reserve Bank
system has improved the transmission from             through its repo operations declined from a
the policy rates to banks’ lending rates.             daily average of around `1,20,000 crore in
                                                      December 2010 to around `81,000 crore in
24.      After remaining in surplus for 18
                                                      March 2011. The average daily net liquidity
months, liquidity conditions transited to a
                                                      injected by the Reserve Bank fell sharply to
deficit	 mode	 towards	 end-May	 2010.	 This	
                                                      `19,000 crore in April 2011 as government
was the consequence of a large build-up
                                                      balances moved from positive to negative.
in government cash balances as a result
of higher than expected proceeds from                 27.     In order to facilitate better liquidity
spectrum auctions. Beginning October                  management, the Reserve Bank extended
2010, liquidity conditions became even                the two liquidity easing measures, viz.,
tighter. Both frictional factors such as the          additional liquidity support under the LAF
above-normal build up in government cash              to SCBs up to one per cent of their NDTL
balances and structural factors such as high          and the SLAF on a daily basis up to May 6,
currency demand growth and credit growth              2011.

28.      Yields on government securities                   in the range of `44.03-47.58 per US dollar.
eased	during	the	first	quarter	of	2010-11	in	              On an average basis, the 6-currency
expectation	 of	 an	 improved	 fiscal	 position	           real effective exchange rate (REER)
due to higher than anticipated revenues                    appreciated by 12.7 per cent in 2010-11,
in spectrum auctions. Yields hardened                      the 30-currency REER by 4.5 per cent and
thereafter till January 2011 on account of                 the 36-currency REER by 7.7 per cent.
increase	 in	 inflation	 and	 consequent	 rate	
                                                           31.	     The	 current	 account	 deficit	 (CAD)	
hike expectations as well as tight liquidity
                                                           during April-December 2010 was US$ 38.9
conditions. Yields, however, moderated in
                                                           billion, up from US$ 25.5 billion during the
February and March 2011 on the back of
                                                           corresponding period of 2009. During the
improvement in liquidity conditions, lower
                                                           fourth quarter of 2010-11, exports grew at a
than	 expected	 budgeted	 fiscal	 deficit	 and	
                                                           robust pace of 46.6 per cent, while growth
the projected market borrowing programme
                                                           in imports decelerated to 22.8 per cent.
for	 the	 first	 half	 of	 2011-12.	 Significantly,	
                                                           Consequently, the CAD, which was 3.1 per
the stability of long-term yields, despite the
                                                           cent during April-December 2010, is now
current	high	rates	of	inflation,	suggests	that	
                                                           estimated to moderate to around 2.5 per cent
inflationary	expectations	remain	anchored.
                                                           of GDP for 2010-11 as against 2.8 per cent
29.       The Union Budget for 2011-12 has                 during 2009-10.
emphasised the Government’s commitment
                                                           32.	    Although	 net	 capital	 inflows	
to	 carry	 on	 the	 process	 of	 fiscal	
                                                           increased	 significantly	 to	 US$	 52.7	 billion	
consolidation	 by	 budgeting	 a	 lower	 fiscal	
                                                           during April-December 2010 (US$ 37.6
deficit	 (4.6	 per	 cent	 of	 GDP	 in	 2011-12	 as	
                                                           billion a year ago), the composition
compared with 5.1 per cent in 2010-11).
                                                           shifted	 towards	 volatile	 flows	 such	 as	
The	revenue	deficit	to	GDP	ratio	is	estimated	
                                                           FII investments and trade credits. Net
to remain unchanged at 3.4 per cent
                                                           inflows	under	FDI	were	lower.	As	the	CAD	
in 2011-12.
                                                           is	 expected	 to	 be	 significant	 in	 2011-12,	
30.    During 2010-11, the rupee dollar                    the	 sustainability	 of	 financing	 it	 becomes	
exchange rate showed two-way movements                     important.

                                  II. outlook and Projections

Global outlook                                             in EMEs is also expected to decelerate on
                                                           account of monetary tightening and rising
                                                           commodity prices.
33.      The global recovery is expected
to sustain in 2011, although growth will
slow down marginally from its pace                         34.     The IMF WEO (April 2011)
in 2010. According to the IMF WEO                          projects	 global	 CPI	 inflation	 to	 rise	 from	
(April 2011), global growth is likely to                   3.7 per cent in 2010 to 4.5 per cent in 2011.
moderate from 5.0 per cent in 2010 to                      While	advanced	economies	face	inflationary	
4.4 per cent in 2011. Growth is projected to               pressures from high commodity prices,
decelerate in advanced economies due to                    EMEs face pressures from both strong
waning	 of	 impact	 of	 	 fiscal	 stimulus,	 and	          domestic demand and high commodity
high oil and other commodity prices. Growth                prices.	 CPI	 inflation	 in	 the	 advanced	

economies is projected to increase from                 of a normal monsoon by the India
1.6 per cent in 2010 to 2.2 per cent in 2011,           Meteorological Department (IMD) during
and in the EMEs from 6.2 per cent to 6.9                2011, agriculture growth is likely to revert
per cent.                                               to its trend growth from the higher base
                                                        of last year. Second, the pace of industrial
Domestic outlook                                        activity has been slowing mainly due to the
                                                        impact of past monetary policy actions and
                                                        high input prices. External demand too may
35.      Real GDP growth for 2010-11 was                slow if global recovery slackens.
estimated at 8.6 per cent. Signs of moderation,
                                                        37.     Based on the assumption of a
however, emerged in the second half of
                                                        normal monsoon and crude oil prices
the	 year.	 Particularly	 significant	 were	 the	
                                                        averaging US$ 110 a barrel over 2011-12, the
slowdown in capital goods production and
                                                        baseline projection of real GDP growth for
investment spending. Going forward, high oil
                                                        2011-12 for policy purposes is placed at
and other commodity prices and the impact
                                                        around 8 per cent. The growth is projected
of	the	anti-inflationary	monetary	stance	will	
                                                        to be in the range of 7.4 per cent and 8.5
weigh	on	growth.	Most	business	confidence	
                                                        per cent in 2011-12 with 90 per cent
surveys conducted by various agencies
                                                        probability (Chart 1).
show	 a	 decline	 in	 business	 confidence.	
The Reserve Bank’s IOS conducted during                 Inflation
March 2011, as mentioned earlier, indicates             38.     The Reserve Bank's forecasts
some moderation in business expectations                systematically under-predicted year-end
for the quarter ended June 2011.                        inflation	 during	 2010-11.	 Even	 after	 a	
36.    Growth is expected to moderate                   significant	 upward	 revision	 from	 5.5	
in 2011-12 from its pace in 2010-11. First,             per cent to 7 per cent in the Third Quarter
notwithstanding the preliminary indication              Policy Review in January 2011 and then to

8 per cent in the Mid-Quarter Review in                 42.      Fourth, there have been sharp
March 2011, the forecasts remained below                increases in the prices of several important
the provisional number of 9 per cent for                industrial raw materials, such as minerals,
March 2011. The analysis in the previous                fibres,	 especially	 cotton,	 rubber,	 besides	
section reveals that the surge in headline              coal and crude oil. In addition, there is also
inflation,	 despite	 an	 overall	 moderation	           upward pressure on wages. The extent to
in	 food	 inflation,	 was	 the	 combination	 of	        which the increase in input prices translates
two factors: an unanticipated increase in               into	output	prices	will	have	an	influence	on	
oil and commodity prices, including the                 the	inflation	path.
large upward revision in administered coal
                                                        43.     Fifth, while the south-west monsoon
prices in March 2011, and demand pressures
                                                        2011 is expected to be normal, its impact
reflected	in	significant	increase	in	inflation	
in non-food manufactured products.                      on	 moderation	 in	 food	 inflation	 may	 be	
                                                        less than commensurate, given a strong
39.      Against this backdrop, several                 structural	component	in	food	inflation	and	
factors	 will	 play	 a	 role	 in	 the	 inflation	       elevated global food price situation.
outlook, going forward. First, there is
a	 significant	 suppressed	 component	 of	              44.      Sixth, even though demand pressures
inflation	as	the	increase	in	crude	oil	prices	          were evidently strong enough to induce the
has not been passed on completely. The                  generalisation of commodity price increases in
last increase in administered mineral oil               recent months, signs of moderation in growth
prices was effected in June 2010 when the               suggest	that	this	driver	of	inflation	will	ease	
Indian basket of crude oil was US$ 74.3 per             in the coming months. The cumulative impact
barrel. Subsequently, it increased to US$               of monetary actions over the past 15 months
110.7 per barrel in March 2011. Similarly,              will continue to be felt over the course of 2011-
administered electricity prices have not gone           12, contributing to moderation in both growth
up even as input prices, particularly those             and	inflation	rates.
of	coal,	have	increased	significantly.	Hence,	          45.      Keeping in view the domestic
the timing of changes in administered prices            demand-supply balance and the global trends
as	 indicated	 above	 will	 have	 a	 significant	       in commodity prices and the likely demand
influence	on	the	inflation	path.                        scenario, the baseline projection for WPI
40.     Second, the outlook for crude oil               inflation	for	March	2012	is	placed	at	6	per	
prices in the near future is uncertain, given           cent	with	an	upward	bias	(Chart	2).	Inflation	
the geo-political situation in the MENA                 is expected to remain at an elevated level
region. In any case, the likelihood of oil              in	the	first	half	of	the	year	due	to	expected	
prices	moderating	significantly	is	low.	The	            pass-through of increase in international
IMF WEO (April 2011) has assumed a                      petroleum product prices to domestic prices
baseline average crude oil price of US$ 107             and continued pass-through of high input
per barrel for 2011 and US$ 108 per barrel              prices into manufactured products.
for 2012.                                               46.     Notwithstanding        the     current
41.     Third, incomplete pass-through of               inflation	 scenario,	 it	 is	 important	 to	
higher crude prices will have an impact on              recognise that in the last decade, the average
aggregate demand though higher subsidy                  inflation	rate,	measured	in	terms	of	WPI	and	
expenditure, which is expansionary and can              CPI, had moderated to around 5.5 per cent.
add	to	inflationary	pressure.                           More	specifically,	non-food	manufacturing	

inflation,	 which	 the	 Reserve	 Bank	 uses	 as	         behaviour of the non-food manufacturing
an indicator of demand pressures and is                  component. This will be in line with the
the most responsive to monetary actions,                 medium-term objective of 3.0 per cent
averaged 4.0 per cent over this period.                  inflation	 consistent	 with	 India’s	 broader	
A	 period	 of	 low	 inflation	 preceded	 the	            integration into the global economy. The
high-growth phase in 2003-08, which was                  achievement of this objective will be helped
in turn characterised by high investment-                by concerted policy actions and resource
GDP	and	declining	fiscal	deficit-GDP	ratios.	            allocations to address domestic bottlenecks,
Inflation	remained	moderate	in	the	early	part	           particularly on the food and infrastructure
of the high-growth phase, but increased in               fronts.
the period immediately preceding the global
financial	crisis,	reflecting	the	emergence	of	           Monetary Aggregates
domestic bottlenecks.
                                                         48.     Keeping in view the need to balance
47.      Based on cross-country as well as
                                                         the resource requirements of the private
domestic experience, the Reserve Bank
                                                         sector and the budgeted government
is strongly of the view that controlling
                                                         borrowings, M3 growth for 2011-12, for
inflation	 is	 imperative	 to	 sustaining	 growth	
over the medium-term. This is a critical                 policy purposes, is placed at 16.0 per cent.
attribute of a favourable investment climate,            Consistent with this, aggregate deposits
on which growth sustainability depends.                  of SCBs are projected to grow by 17.0
Fiscal consolidation will also contribute                per cent. Growth in non-food credit of
to improving the investment climate.                     SCBs is projected at 19.0 per cent. These
Accordingly, the conduct of monetary                     monetary projections are consistent with
policy will continue to condition and contain            the	growth	and	inflation	outlook.	As	always,	
perceptions	 of	 inflation	 in	 the	 range	 of	          the numbers are provided as indicative
4.0-4.5 per cent, with particular focus on the           projections and not as targets.

Risk Factors                                           challenge, given the subsidy burden arising
49.     The indicative projections of growth           out of high international prices, the effect of
and	 inflation	 for	 2011-12	 are	 subject	 to	        which has not been completely passed on.
several risks as detailed below:                       The Government, therefore, needs to focus
                                                       on the quality of expenditure to sustain the
i)      There are several downside risks               fiscal	consolidation	process,	which,	in	turn,	
to global growth at this stage such as                 will help contain aggregate demand.
(a) sovereign debt problem in the euro area
periphery intensifying and spreading to the            iv)	    Food	 inflation,	 after	 remaining	
core; (b) high commodity prices, especially            in double digits for more than two years,
oil, impacting the global recovery;                    declined to a single digit rate in November
(c) abrupt rise in long-term interest rates            2010. However, despite normal monsoon
in highly indebted advanced economies                  in	2010,	food	price	inflation	did	not	show	
with	 implications	 for	 fiscal	 path;	 and	           the usual moderation. Furthermore,
(d)	 accentuation	 of	 inflationary	 pressures	        vegetable prices also did not exhibit the
in EMEs. Should global recovery slacken                usual seasonal pattern in 2010-11. This
significantly,	 it	 will	 impact	 the	 Indian	         suggests that supply is not able to keep
economy	 through	 the	 trade,	 finance	 and	           pace with the growing demand. Given the
confidence	channels.                                   spike in international food prices even in
ii)     Global commodity prices are a                  significantly	traded	food	items,	imports	do	
significant	 risk	 factor	 for	 both	 domestic	        not provide an option to cushion domestic
growth	 and	 inflation.	 The	 future	 path	 of	        prices. Persistently high food prices are
crude oil prices is uncertain. Brent crude             likely to exert sustained upward pressure
crossed US$ 120 per barrel in April 2011.              on wages, thus transmitting through to
Metal prices, which witnessed some decline             wider cost pressure on prices.
around	 mid-March	 2011,	 reflecting	 the	             v)      If oil and commodity prices remain
weakening	 of	 investor	 confidence	 due	 to	          elevated,	the	CAD	will	remain	significant.	
the Japanese disaster, have resumed their              Financing of CAD is going to be a challenge
upward trend.                                          as advanced countries begin exiting from
iii)	   The	 budgeted	 fiscal	 deficit	 for	           their accommodative monetary policy
2011-12 gives some comfort on the demand               stance.	This	could	slow	down	capital	inflows	
front.	 However,	 achieving	 the	 fiscal	              to EMEs, including India, as investors
consolidation targets for 2011-12 could be a           rebalance their portfolios.

                                   III. the Policy stance
50.     The Reserve Bank began exiting                 policy rates has been of 350 basis points as
from the crisis driven accommodative                   the liquidity in the system transited from a
policy in October 2009. Since then, the cash           surplus	to	a	deficit	mode.
reserve ratio (CRR) has been raised by 100             51.     The monetary policy stance in
basis points. Policy rates have been raised            2010-11 was calibrated on the basis of the
eight times - the repo rate under the LAF by           domestic	growth-inflation	dynamics	amidst	
200 basis points and the reverse repo rate by          persistent global uncertainties. Against
250 basis points. The effective tightening in          the backdrop of global and domestic

macroeconomic      conditions,   outlook                   respect to capital goods and investment
and risks, the policy stance for 2011-12                   activity. Growth is expected to decelerate
has been guided by the following major                     from 8.6 per cent in 2010-11 to around 8 per
considerations.                                            cent in 2011-12, which should contribute to
52.      First,      notwithstanding        some           some	 easing	 of	 demand-side	 inflationary	
moderation in the second half of the year,                 pressures, particularly in the second half,
inflation	 has	 persistently	 remained	 much	              as the full impact of monetary tightening
above the comfort level of the Reserve                     is realised. However, even as this trend
Bank. The sharp increase in non-food                       unfolds,	persistently	high	rates	of	inflation	
manufactured	 product	 inflation	 towards	                 raise	 the	 risks	 of	 inflationary	 expectations	
the latter part of the year suggests strong                becoming unhinged.
underlying demand pressures, which are
                                                           54.     Against this backdrop, the stance of
helping producers to pass through input
                                                           monetary policy of the Reserve Bank will
price increases. The uncertainty in global
commodity prices poses a major risk to                     be as follows:
domestic	inflation	as	the	significant	increase	            •	   Maintain	 an	 interest	 rate	 environment	
in global crude prices that has already taken                   that	 moderates	 inflation	 and	 anchors	
place, is yet to be passed through to domestic                  inflation	expectations.
prices. The impact of monetary tightening
already undertaken by the Reserve Bank is                  •	   Foster	an	environment	of	price	stability	
still unfolding. However, considering the                       that is conducive to sustaining growth
overall	 inflation	 scenario,	 there	 is	 a	 clear	             in the medium-term coupled with
need	 to	 persist	 with	 the	 anti-inflationary	                financial	stability.
stance.                                                    •	   Manage	 liquidity	 to	 ensure	 that	 it	
53.      Second,     while     the     growth                   remains broadly in balance, with neither
momentum	remained	relatively	firm	during	                       a large surplus diluting monetary
2010-11, signs of moderation emerged in                         transmission	nor	a	large	deficit	choking	
the latter half of the year, particularly with                  off	fund	flows.

                                    IV. Monetary Measures
Report of the Working Group on                             feedback received, it has been decided to
operating Procedure of Monetary Policy                     make the following changes in the extant
55.     Following the First Quarter Review                 operating procedures of monetary policy:
of Monetary Policy for 2010-11 (July 2010),                (i) The weighted average overnight call
the Reserve Bank constituted a Working                         money rate will be the operating target
Group to Review the Operating Procedure                        of monetary policy of the Reserve
of Monetary Policy in India (Chairman:                         Bank.
Shri Deepak Mohanty). The Report of the                    (ii) There will henceforth be only one
Group was placed in public domain on March                      independently varying policy rate
15, 2011 for feedback and comments.                             and that will be the repo rate. The
56.   Based     on     the      Group’s                         transition to a single independently
recommendations and in the light of the                         varying policy rate is expected to more

     accurately signal the monetary policy                  operating procedures as set out above, the
     stance.                                                Reserve Bank announces the following
(iii) The reverse repo rate will continue to                policy measures:
      be operative but it will be pegged at a
      fixed	 100	 basis	 points	 below	 the	 repo	          Repo Rate
      rate. Hence, it will no longer be an                  59.      It has been decided to:
      independent rate.
                                                            l     increase the repo rate under the liquidity
(iv) A new Marginal Standing Facility                             adjustment facility (LAF) by 50 basis
     (MSF) will be instituted from which                          points from 6.75 per cent to 7.25 per
     SCBs can borrow overnight up to                              cent with immediate effect.
     one per cent of their respective
     NDTL. The rate of interest on amount                   Reverse Repo Rate
     accessed from this facility will be 100
     basis points above the repo rate. A                    60.    The reverse repo rate under the LAF,
     notification	is	being	issued	separately	               determined with a spread of 100 basis point
     providing for a general waiver of                      below the repo rate, automatically adjusts to
     default from SLR compliance, freeing                   6.25 per cent with immediate effect.
     banks from the obligation of seeking
     a	 specific	 waiver	 of	 default	 as	 is	 the	         Marginal standing Facility (MsF) Rate
     case now. This facility is expected                    61.     The Marginal Standing Facility
     to contain volatility in the overnight                 (MSF) rate, determined with a spread of
     inter-bank market.                                     100 basis points above the repo rate, stands
(v) As per the above scheme, the revised                    calibrated at 8.25 per cent. This rate will
    corridor	will	have	a	fixed	width	of	200	                come into effect on operationalisation of the
    basis points. The repo rate will be in the              MSF.
    middle. The reverse repo rate will be
    100 basis points below it and the MSF                   Bank Rate
    rate 100 basis points above it.                         62.     The Bank Rate has been retained at
(vi)	 While	the	width	of	the	corridor	is	fixed	             6.0 per cent.
      at 200 basis points, the Reserve Bank
      will	 have	 the	 flexibility	 to	 change	 the	        cash Reserve Ratio
      corridor, should monetary conditions                  63.     The cash reserve ratio (CRR) of
      so warrant.                                           scheduled banks has been retained at 6.0
57.     The above changes in the operating                  per cent of their NDTL.
framework other than at (iv) above will                     savings Bank Deposit Interest Rate
come into force with immediate effect.
                                                            64.     As indicated in the Second Quarter
Change under (iv) will come into effect
                                                            Review of Monetary Policy 2010-11, the
from the fortnight beginning May 7, 2011.
                                                            discussion paper delineating the pros and
Detailed guidelines in this regard are being
                                                            cons of deregulating the savings bank
issued separately.
                                                            deposit interest rate was placed on the
58.     On the basis of the policy stance                   Reserve Bank’s website on April 28, 2011
as outlined in Section III, and changes in                  for feedback from the general public.

65.    In the recent period, the spread              Guidance
between the savings deposit and term                 68.	     The	 Bank's	 baseline	 inflation	
deposit	 rates	 has	 widened	 significantly.	        projections, as indicated in Chart 2 (page 9),
Therefore,	 pending	 a	 final	 decision	 on	         are	that	the	inflation	rate	will	remain	close	
the issue of deregulation of savings                 to	the	March	2011	level	over	the	first	half	of	
bank deposit interest rate, it has been              2011-12, before declining. These projections
decided to :                                         factor in an upward revision of petrol and
                                                     diesel prices. While the persistence of
•	   increase	 the	 savings	 bank	 deposit
                                                     inflation	over	the	next	few	months	has	been	   	
     interest rate from the present 3.5
                                                     incorporated in this policy, the Reserve
     per cent to 4.0 per cent with immediate         Bank will continue to persevere with its
     effect.                                         anti-inflationary	stance.
66.    Detailed instructions in this regard
to banks are being issued separately.                Mid-Quarter Review of Monetary Policy
                                                     69.   The next mid-quarter review
expected outcomes                                    of Monetary Policy for 2011-12 will be
67.    The monetary policy actions in this           announced through a press release on
review are expected to:                              Thursday, June 16, 2011.

i)	 contain	inflation	by	reining	in	demand	          First Quarter Review of Monetary
    side	pressures,	and	anchor	inflationary	         Policy 2011-12
    expectations; and
                                                     70.     The First Quarter Review of
ii) sustain the growth in the medium-term            Monetary Policy for 2011-12 is scheduled
    by	containing	inflation.                         for Tuesday, July 26, 2011.

                 Part B. Developmental and Regulatory Policies

71.     This part of the Statement reviews               (BCBS) and Financial Stability Board (FSB),
the progress in various developmental and                which are engaged in setting standards and
regulatory policy measures announced                     formulating policies for safeguarding the
by the Reserve Bank in the recent policy                 financial	system.	
statements and also sets out new measures.
                                                         73.      The Reserve Bank has already
72.	     The	 global	 financial	 crisis	 has	            indicated that it would implement the reform
exposed	areas	of	vulnerability	in	the	financial	         measures under Basel III framework, which
sector and policy initiatives are underway to            are applicable to banks in India. Apart from
strengthen	 financial	 stability.	 Some	 of	 the	        reforms in the banking sector, the Reserve
key issues that have arisen in the banking               Bank has also been pursuing reforms in
sector are inadequate loss-absorbing capital;            several other areas. It has been actively
insufficient	 liquidity	 buffers;	 excessive	            pursuing the development of various
build-up of leverage; procyclicality of                  segments	 of	 the	 financial	 market.	 In	 the	
financial	 markets;	 focus	 on	 firm-specific	           recent	 period,	 financial	 inclusion	 has	 also	
supervision and neglect of macro-prudential              been recognised as a key objective of policy.
supervision of system-wide risks; moral                  In addition, greater emphasis is being
hazard from too-big-to-fail institutions; weak           placed on the quality of service rendered
governance practices; poor understanding of              by banks to their customers. Information
complex products; and shortcomings in risk               technology and payment and settlement
management. With a view to addressing these              services have a crucial role in ensuring not
issues, various international bodies, national           only	 efficient	 banking	 services	 but	 also	 in	
supervisors and policymakers are engaged                 financial	 stability,	 financial	 inclusion	 and	
in instituting various reform measures at                customer service. It has, therefore, been the
the global and at the national levels. The               endeavour of the Reserve Bank to promote
Reserve Bank has been playing an active role             the use of information technology in banks
in various international fora, including G-20,           and	 provide	 secure	 and	 efficient	 payment	
Basel Committee on Banking Supervision                   and settlement services in the country.

                                     I. Financial stability
Financial stability Report                               healthy. The stress testing on credit, market
74.     It was announced in the Second                   and liquidity risks indicated a reasonable
Quarter Review of Monetary Policy of                     degree of resilience of the banking sector
November 2010 that the Financial Stability               in India. The report also pointed to some
Report (FSR) would be regularly published in             discernible soft spots such as volatile capital
June and December every year. Accordingly,               flows,	stretched	fiscal	conditions,	persisting	
the second FSR was released by the Reserve               inflationary	 pressure,	 deterioration	 in	 asset	
Bank in December 2010. The report brought                quality of banks, regulatory gaps in the non-
out	that	the	financial	sector	remained	stress-           banking	 financial	 sector,	 and	 underscored	
free notwithstanding intermittent volatility,            the need for setting up a robust macro-
especially in the equity and foreign exchange            prudential	 framework	 for	 identification	 of	
markets. Financial institutions remained                 systemic risks.

                                   II. Interest Rate Policy

Base Rate                                                computing the Base Rate. Subsequently,
75.    The Reserve Bank introduced the                   some banks requested for extension of
Base Rate System from July 2010, which                   time. Accordingly, banks were permitted
replaced the benchmark prime lending rate                to change the benchmark and methodology
(BPLR) system. Banks were given time till                used in the computation of their Base Rates
end-December 2010 to select the appropriate              for a further period of six months, i.e., up to
benchmark and other cost parameters for                  June 30, 2011.

                                    III. Financial Markets

Financial Market Products                                in February 2011 for public comments.
                                                         The	 guidelines	 are	 being	 finalised,	 based	
Interest Rate Futures
                                                         on feedback from the public, extensive
76.     It was indicated in the Second                   consultations with the stakeholders and
Quarter Review of November 2010 that                     deliberations in the Technical Advisory
exchange traded interest rate futures (IRFs)             Committee      on      Financial     Markets.
on 5-year and 2-year notional coupon                     Accordingly, it is proposed:
bearing central government securities and
                                                         •	   to	 issue	 the	 final	 guidelines	 on	 plain	
91-day Treasury Bills would be introduced
                                                              vanilla single-name CDS for corporate
after taking into account the experiences of
                                                              bonds for resident entities, after taking
cash-settled IRF regimes in other countries.
                                                              into consideration the feedback/
The IRF trading on 91-day Treasury Bills
                                                              suggestions received from market
with cash settlement in Indian Rupees was                     participants, by end-May 2011.
permitted by the Reserve Bank in March
2011. The guidelines for 5-year and 2-year               78.     The product will be launched once the
IRFs	 are	 being	 finalised	 in	 consultation	           necessary market infrastructure is in place.
with the Securities and Exchange Board of                Review of Short Sale in Government
India (SEBI).                                            Securities
Introduction of Credit Default Swaps                     79.     Based on the recommendations of the
77.      It was announced in the Second                  Technical Group on the Central Government
Quarter Review of           October 2009 to              Securities Market, intra-day short selling in
introduce plain vanilla over-the-counter                 central government securities was permitted
(OTC) single-name credit default swap                    in February 2006. Subsequently, based on
(CDS) for corporate bonds for resident                   the feedback received, the period of short
entities, subject to appropriate safeguards.             sale	 was	 extended	 to	 five	 days	 in	 January	
Consequently, an internal Working Group                  2007.	With	a	view	to	providing	a	fillip	to	the	
was	 constituted	 to	 finalise	 the	 operational	        IRF market and the term repo market, it is
framework in consultation with market                    proposed:
participants.	The	final	report	of	the	internal	          •	   to	extend	the	period	of	short	sale	from	
Working Group and draft guidelines on CDS                     the	 existing	 five	 days	 to	 a	 maximum	
were placed on the Reserve Bank’s website                     period of three months.

                                                        (ii) permitting use of cost reduction
Extension of DvP III Facility to
                                                        structures, both under the contracted
Gilt Account Holders
                                                        exposures and past performance routes,
80.      Consequent upon the announcement               subject to certain safeguards.
made in the Mid-term Review of Monetary
and Credit Policy for the year 2003-04, the             Cancellation and Rebooking under the
settlement of transactions in government                Portfolio Investment Scheme by FIIs
securities through Clearing Corporation                 83.     Currently, foreign institutional
of India Ltd. (CCIL) was switched over to               investors (FIIs) are permitted to cancel and
delivery versus payment (DvP) III mode                  rebook 2 per cent of the market value of the
with effect from April 2, 2004. However, the            portfolio	as	at	the	beginning	of	the	financial	
DvP III mode of settlement was not extended             year. In view of the large positions held by
to gilt account holders who maintained their            the FIIs and considering the increased depth
balances with the custodian bank/primary                of the Indian forex market to absorb the
dealer who, in turn, held these securities              impact on the exchange rate, it is proposed:
in its constituent subsidiary general ledger
                                                        •	   to	 allow	 FIIs	 to	 cancel	 and	 rebook	 up	
(CSGL) account with the Reserve Bank.
                                                             to 10 per cent of the market value of
With the stabilisation of the transaction
                                                             the portfolio as at the beginning of the
and settlement infrastructure, it is now
                                                             financial	year.	
                                                        84.     Detailed guidelines in this regard
•	   to	extend	DvP	III	facility	to	transactions	
                                                        will be issued separately.
     by the gilt account holders (excluding
     transactions between the gilt account              Facilitating Rupee Trade –
     holders of the same custodian) so that             Hedging Facilities for Non-resident Entities
     the	gilt	account	holders	get	the	benefit	
                                                        85.     The provisions under the Foreign
     of	efficient	use	of	funds	and	securities.	
                                                        Exchange Management Act (FEMA),
81.     Detailed guidelines in this regard              1999 do not permit non-residents to hedge
will be issued shortly.                                 their currency exposure with authorised
                                                        dealer (AD) banks in India, in respect of
Guidelines on Over-the-Counter
                                                        exports and imports invoiced in Indian
Forex Derivatives
                                                        Rupees. In order to facilitate greater use
82.      It was proposed in the Second                  of Indian Rupee in trade transactions, it is
Quarter Review of November 2010 to issue                proposed:
final	 guidelines	 on	 OTC	 foreign	 exchange	
                                                        •	   that	 in	 respect	 of	 exports	 and	 imports	
derivatives by end-November 2010.
                                                             invoiced in Indian Rupees, non-resident
Accordingly, comprehensive guidelines
                                                             importers and exporters can hedge their
on OTC foreign exchange derivatives
                                                             currency risk with AD banks in India
and overseas hedging of commodity
                                                             through their bankers having Rupee
price and freight risks were issued in
                                                             vostro accounts in India. The contracts
December 2010. The important elements
                                                             would be on a deliverable basis.
of the revised guidelines, which became
effective February 1, 2011, are (i) allowing            86.     The operational details will be
embedded cross currency option in the                   finalised	 and	 notified	 in	 consultation	 with	
case of foreign currency-rupee swaps; and               the stakeholders.

Financial Market Infrastructure                        FEMA. Keeping this in view, a Committee
                                                       (Chairperson: Smt. K.J. Udeshi) comprising
Committee for Review of Procedures
                                                       the representatives of various stakeholders
relating to Facilities to Individuals –
                                                       has been set up. The Committee will identify
Residents/NRIs and PIOs
                                                       areas for streamlining and simplifying the
87.     The Reserve Bank recognises                    procedure so as to remove the operational
the need for facilitating genuine foreign              impediments, and assess the level of
exchange transactions by individuals –                 efficiency	 in	 the	 functioning	 of	 authorised	
residents/non-resident Indians (NRIs) and              persons, including the infrastructure created
persons of Indian origin (PIOs) – under                by them. The Committee is expected to
the current regulatory framework of                    submit its report within three months.

                      IV. credit Delivery and Financial Inclusion
credit Flow to the Micro, small and                    Rural credit Institutions
Medium enterprises sector
                                                       Licensing of Co-operatives
High Level Task Force on MSMEs
                                                       89.     In terms of the recommendations
88.     As indicated in the Second Quarter             of the Committee on Financial Sector
Review of November 2010, the Reserve                   Assessment (Chairman: Dr. Rakesh Mohan
Bank, based on the recommendations of                  and Co-Chairman: Shri Ashok Chawla)
the High Level Task Force on Micro, Small              and as proposed in the Annual Policy
and Medium Enterprises (MSMEs), issued                 Statement of April 2009, the work relating
guidelines in June 2010, advising scheduled            to licensing of unlicensed state and central
commercial banks that the allocation of                co-operative banks in a non-disruptive
60 per cent of micro and small enterprises             manner, in consultation with National Bank
(MSEs) advances to the micro enterprises               for Agriculture and Rural Development
was to be achieved in stages, viz., 50 per cent        (NABARD), was initiated. Subsequent to the
in the year 2010-11, 55 per cent in the year           issuance of revised guidelines on licensing
2011-12 and 60 per cent in the year 2012-13.           of state co-operative banks (StCBs)/district
Further, banks were mandated to achieve                central co-operative banks (DCCBs),
a 10 per cent annual growth in the number              10 StCBs and 144 DCCBs were licensed,
of micro enterprise accounts and a 20 per              bringing down the number of unlicensed
cent year-on-year growth in credit to the              StCBs from 17 to 7 and unlicensed DCCBs
MSE sector. The Reserve Bank is closely                from 296 to 152 as on March 31, 2011.
monitoring the achievement of targets by
                                                       Revival of the Rural Co-operative
banks on a half-yearly basis, i.e., March
                                                       Credit Structure
and September each year. A suitable format
has been devised by the Reserve Bank to                90.    The Government of India, based
capture and monitor the achievement of the             on the recommendations of the Task
targets by banks and the same are regularly            Force on Revival of Rural Co-operative
reviewed at the highest level. Banks, which            Credit Institutions (Chairman: Prof. A.
lag behind in achieving the targets, have              Vaidyanathan) and in consultation with
been mandated to submit an action plan to              the State Governments, had approved a
achieve the prescribed targets.                        package for revival of the short-term rural

co-operative credit structure. As envisaged               the Reserve Bank (Chairman: Shri Y. H.
in the package, 25 States have entered into               Malegam) was constituted to study issues
memorandum of understanding (MoU) with                    and concerns in the MFI sector. The
the Government of India and NABARD                        Committee submitted its report in January
and 20 States have amended their respective               2011, which was placed in public domain.
State Co-operative Societies Acts. As on                  The Committee, inter alia, recommended
February 28, 2011, an aggregate amount                    (i) creation of a separate category of
of `8,460 crore was released by NABARD                    NBFC-MFIs; (ii) a margin cap and
for recapitalisation of primary agricultural              an interest rate cap on individual
credit societies (PACS) in 16 States as the               loans; (iii) transparency in interest
Government of India’s share under the                     charges; (iv) lending by not more than
revival package.                                          two MFIs to individual borrowers;
Financial Inclusion through                               (v) creation of one or more credit
Grass-root Co-operatives                                  information bureaus; (vi) establishment
                                                          of a proper system of grievance redressal
91.     It was proposed in the Monetary                   procedure by MFIs; (vii) creation of one
Policy Statement of April 2010 to constitute a            or more “social capital funds”; and (viii)
committee comprising representatives from                 continuation of categorisation of bank loans
the Reserve Bank, NABARD and a few State                  to MFIs, complying with the regulation
Governments to study the functioning of                   laid down for NBFC-MFIs, under the
well-run PACS, large adivasi multi-purpose                priority sector. The recommendations of
co-operative societies (LAMPS), farmers                   the Committee were discussed with all
service societies (FSS) and thrift and credit             stakeholders, including the Government
co-operative societies set up under the                   of India, select State Governments,
parallel Self-Reliant Co-operative Societies              major NBFCs working as MFIs, industry
Acts to gather information on their working               associations of MFIs working in the
and assess their potential to contribute to               country, other smaller MFIs, and major
financial	 inclusion.	 The	 regional	 offices	 of	        banks. In the light of the feedback received,
the Reserve Bank have since given their                   it has been decided:
inputs. Analysis, consolidation of data and
preparation of State-wise reports are in                  •	   to	 accept	 the	 broad	 framework	 of	
progress and are expected to be completed                      regulations recommended by the
by end-July 2011.                                              Committee;
                                                          •	   that	 bank	 loans	 to	 all	 MFIs,	 including	
Malegam committee Recommendations                              NBFCs working as MFIs on or after
                                                               April 1, 2011, will be eligible for
92.      In the wake of the Andhra Pradesh
                                                               classification	 as	 priority	 sector	 loans	
micro	finance	crisis	in	2010,	concerns	were	
                                                               under respective category of indirect
expressed by various stakeholders and the
                                                               finance	only	if	the	prescribed	percentage	
need was felt for more rigorous regulation
                                                               of their total assets are in the nature of
of	 non-banking	 financial	 companies	
                                                               "qualifying assets" and they adhere to
(NBFCs)	 functioning	 as	 micro	 finance	
                                                               the "pricing of interest" guidelines to be
institutions (MFIs). As indicated in the
                                                               issued in this regard;
Second Quarter Review of November 2010,
a Sub-Committee of the Central Board of                   •	   that	 a	 “qualifying	 asset’’	 is	 required	

     to satisfy the criteria of (i) loan                to	 relook	 at	 the	 definition	 of	 the	 priority	
     disbursed by an MFI to a borrower                  sector,	 especially	 when	 bank	 finance	 was	
     with a rural household annual income               being routed through other agencies. It is,
     not exceeding `60,000 or urban and                 therefore, proposed:
     semi-urban household income not                    •	   to	 appoint	 a	 committee	 to	 re-examine	
     exceeding `1,20,000; (ii) loan amount                   the	 existing	 classification	 and	 suggest	
     not to exceed `35,000	in	the	first	cycle	               revised guidelines with regard to
     and `50,000 in subsequent cycles;                       priority	sector	lending	classification.
     (iii) total indebtedness of the borrower
     not to exceed `50,000; (iv) tenure
                                                        Financial Inclusion Plan for Banks
     of loan not to be less than 24 months
     for loan amount in excess of `15,000               95.      As indicated in the Second Quarter
     without prepayment penalty; (iv) loan              Review of November 2010, all public and
     to be extended without collateral;                 private sector banks were advised to put in
     (v) aggregate amount of loan, given                place	a	Board	approved	three-year	financial	
     for income generation, not to be less              inclusion plans (FIPs) and submit them to
     than 75 per cent of the total loans                the Reserve Bank by March 2010. These
     given by the MFIs; and (vi) loan to                banks have since prepared and submitted
     be repayable by weekly, fortnightly or             their FIPs containing targets for March
     monthly instalments at the choice of               2011, 2012 and 2013, to the Reserve Bank.
     the borrower;                                      These plans broadly include self-set targets
                                                        in respect of rural brick and mortar branches
•	   that	banks	should	ensure	a	margin	cap	             opened; business correspondents (BCs)
     of 12 per cent and an interest rate cap            employed; coverage of unbanked villages
     of 26 per cent for their lending to be             with population above 2,000 as also other
     eligible	 to	 be	 classified	 as	 priority	        unbanked villages with population below
     sector loans;                                      2,000 through branches/BCs/other modes;
•	   that	loans	by	MFIs	can	also	be	extended	           no-frill accounts opened including through
     to individuals outside the self-help               BC-ICT; kisan credit cards (KCCs) and
     group (SHG)/joint liability group (JLG)            general credit cards (GCCs) issued; and
     mechanism; and                                     other	specific	products	designed	by	them	to	
                                                        cater	to	the	financially	excluded	segments.	
•	   that	bank	loans	to	other	NBFCs	would	
     not be reckoned as priority sector loans           96.     The implementation of these plans
     with effect from April 1, 2011.                    is being closely monitored by the Reserve
                                                        Bank on a quarterly basis. The analysis of
93.     Detailed guidelines in this regard
                                                        progress reports of above plans received from
will be issued separately.
                                                        all public and private sector banks shows
                                                        that during the period April 2010 to March
Redefining the Priority Sector
                                                        2011, banks opened 5,214 new branches,
94.     The     Malegam       Committee                 deployed 25,403 BCs/customer service
recommended that the existing guidelines                providers (CSPs) and provided banking
on bank lending to the priority sector be               services in 43,337 villages. Out of these,
revisited. Requests were also received                  525 villages were covered through rural
from various quarters in the recent past                brick and mortar branches, 42,506 villages

through BCs and 306 villages through other            domestic SCBs are being mandated:
modes such as ATMs and mobile vans. It is
                                                      •	   to	 allocate	 at	 least	 25	 per	 cent	 of	 the	
important to note that banks covered 24,066
                                                           total number of branches to be opened
villages with population above 2,000, in
                                                           during a year to unbanked rural (Tier 5
addition to covering 19,271 villages with
                                                           and Tier 6) centres.
population below 2,000.
                                                      Urban co-operative Banks
Branch Authorisation Policy
                                                      Licenses for Setting up new Urban
97.      Domestic scheduled commercial
                                                      Co-operative Banks
banks (excluding regional rural banks
[RRBs]) were permitted in December                    99.     As announced in the Monetary
2009 to open branches in Tier 3 to Tier               Policy Statement of April 2010, an
6 centres (with population up to 49,999)              Expert Committee (Chairman: Shri Y. H.
without prior permission of the Reserve               Malegam) was constituted in October 2010
Bank. However, prior authorisation from               with representations from all stakeholders
the Reserve Bank was required for opening             for studying the advisability of granting
of branches in Tier 1 and Tier 2 centres              licenses for setting up new urban
which was granted based, inter alia, on the           co-operative banks (UCBs) under Section
(i) number of branches opened in Tier 3 to            22 of the Banking Regulation Act, 1949
Tier 6 centres under general permission;              [as applicable to co-operative societies
(ii) branches proposed to be opened in under-         (AACS)]. The Committee will also look into
banked districts in under-banked States;              the feasibility of an umbrella organisation for
and (iii) bank's performance in areas of              the UCB sector. The Committee is expected
financial	inclusion	and	customer	service.	It	         to submit its report by end-June 2011.
was observed that on an average scheduled             Financing of Self-Help Group/Joint
commercial banks (SCBs) opened about                  Liability Group by UCBs
20 per cent of the total number of new
branches in rural centres (Tier 5 and Tier            100. With a view to further expanding
6) in the last two years.                             the outreach of UCBs and opening an
                                                      additional	 channel	 for	 promoting	 financial	
98.     There is a need to step up the                inclusion, which would also help the UCBs
opening of branches in rural areas so as to           in achieving the sub-target of lending to
improve	 banking	 penetration	 and	 financial	        weaker sections, it is proposed:
inclusion rapidly and meet the targets
set out for providing banking services in             •	   to	permit	UCBs	to	lend	to	SHGs/JLGs;	
villages with population over 2,000. The                   and
FIPs submitted by banks indicate that                 •	   to	 keep	 lending	 to	 SHGs	 out	 of	 the	
banks propose to use BCs in a big way to                   norm on unsecured advances.
reach out to unbanked villages. Keeping in
                                                      Exposure of UCBs to Housing,
view the goal of bringing banking services
                                                      Real Estate and Commercial Real Estate
to	identified	72,800	villages	by	March	2012	
and thereafter progressively to all villages          101.   Pursuant to the announcements
over a period of time, there is a need for            made in the Second Quarter Review of
opening of more brick and mortar branches,            November 2010, UCBs were permitted to
besides the use of BCs. Accordingly,                  lend up to 10 per cent of their total assets

to housing, real estate and commercial real             UCBs were allowed the facility of
estate and an additional 5 per cent of total            Indian Financial Network (INFINET)
assets for purchase and construction of                 membership, current and subsidiary
dwelling units costing up to `10 lakh.                  general ledger (SGL) accounts with
Keeping in view the representations received            the Reserve Bank and real time gross
from UCBs and their associations that they              settlement (RTGS) membership to well
are	finding	it	difficult	to	use	the	additional	         managed	 and	 financially	 sound	 UCBs	
limit of 5 per cent of total assets due to the          having a minimum net worth of `25 crore.
high cost of dwelling units, it is proposed:            In order to further enable UCBs to serve
•	   to	 permit	 UCBs	 to	 utilise	 the                 their customers better, it is now proposed:
     additional 5 per cent of their total               •	   to	permit	well	managed	and	financially	
     assets permitted earlier, for housing                   sound UCBs to become members of the
     loans up to `15 lakh.                                   negotiated dealing system (NDS).
Internet Banking Facility                               105. Detailed guidelines are being issued
102. With increasing expectation of                     separately.
customers of UCBs for better products and
services on par with commercial banks,                  customer service
the opening up of internet banking channel
                                                        106. Pursuant to the announcement made
to UCBs will enable them to retain their
                                                        in the Monetary Policy Statement of April
customer base. It is, therefore, proposed:
                                                        2010, a Committee on Customer Service
•	   to	 permit	 scheduled	 UCBs	 satisfying	           (Chairman: Shri M. Damodaran) was
     certain criteria to provide internet               constituted to look into banking services
     banking facility to their customers.               rendered to retail and small customers,
103. Detailed guidelines will be issued                 including pensioners. Apart from formal
separately.                                             meetings, the Committee members
                                                        have conducted meetings with various
Membership of Negotiated Dealing System                 stakeholders across the length and breadth
104. Pursuant to the Second Quarter                     of the country. The report is in the process
Review of November 2010, all licensed                   of	being	finalised.

         V. Regulatory and supervisory Measures for commercial Banks
strengthening the Resilience of the                     had issued certain enhancements to Basel
Banking sector                                          II Framework, including amendments to the
                                                        market risk framework in July 2009, which
107.	 After	the	financial	crisis,	the	BCBS	
                                                        were implemented by the Reserve Bank with
has taken a number of initiatives with a view           effect from March 31, 2010. In December
to improving the banking sector’s ability to            2010, the BCBS released a comprehensive
absorb	 shocks	 arising	 from	 financial	 and	          package of further reforms which, together
economic stress and to reduce the risk of               with the July 2009 enhancements, is known
spillover	from	the	financial	sector	to	the	real	        as the Basel III framework. This reform
economy. It may be recalled that the BCBS               package aims at (i) increasing the quality and

quantity of the capital with greater emphasis           enhancement of Rates of Provisioning
on common equity; (ii) increasing the risk              for non-Performing Assets
coverage; (iii) introducing a leverage ratio            110.    In pursuance of the announcement
as a back stop to the risk-based capital ratio;         made in the Second Quarter Review of
and (iv) introducing capital conservation               October 2009, banks were advised in
and counter-cyclical capital buffers to                 December 2009 to achieve a provisioning
ensure build up of additional capital in                coverage ratio (PCR) of 70 per cent
good times, thereby protecting banks from               for their non-performing advances by
the dangers of excessive credit growth.                 end-September 2010. This coverage ratio
Besides, the Committee has also introduced              was intended to achieve a counter-cyclical
liquidity ratios with a view to ensuring that           objective by ensuring that banks build up
banks maintain adequate liquidity buffers               a good cushion of provisions to protect
and reduce maturity mismatches.                         them from any macroeconomic shock in
108. The Reserve Bank would adhere                      future. In April 2011, banks were advised
to    internationally   agreed     phase-in             to segregate the surplus of provisions
period (beginning January 1, 2013) for                  under the PCR vis-a-vis as required as per
implementation of the Basel III framework.              prudential norms as on September 30, 2010,
The Reserve Bank is studying the Basel III              into an account styled as “counter-cyclical
reform measures for preparing appropriate               buffer”. While the “counter-cyclical buffer”
guidelines for implementation. It is taking             so created would be available to banks for
steps to disseminate information on Basel               making	specific	provisions	during	economic	
III and help banks prepare for smooth                   downturns, there is a need for banks to
                                                        make	higher	specific	provisions	also	as	part	
implementation of the framework.
                                                        of the prudential provisioning framework.
                                                        Accordingly, It is proposed to enhance
Implementation of Advanced Approaches
                                                        the provisioning requirements on certain
under Basel II Framework
                                                        categories of non-performing advances and
109. The Reserve Bank had announced                     restructured advances as under:
timeline for implementation of advanced
                                                        •	   advances	 classified	 as	 “sub-standard”	
approaches for computation of regulatory
                                                             will attract a provision of 15 per cent
capital under the Basel II framework                         as against the existing 10 per cent
in India in July 2009. The guidelines                        (the	 “unsecured	 exposures”	 classified	
for the standardised approach (TSA)/                         as sub-standard assets will attract an
alternate standardised approach (ASA) for                    additional provision of 10 per cent,
operational risk were issued in March 2010                   i.e., a total of 25 per cent as against the
and those for internal models approach                       existing 20 per cent);
(IMA) for market risk in April 2010. Draft
guidelines for advanced measurement                     •	   the	secured	portion	of	advances	which	
approach (AMA) for operational risk were                     have remained in “doubtful” category
issued in January 2011 for public comments/                  up to one year will attract a provision
feedback,	 and	 final	 guidelines	 were	 issued	             of 25 per cent (as against the existing
in April 2011. Guidelines for internal rating                20 per cent);
based (IRB) approach for credit risk are                •	   the	secured	portion	of	advances	which	
under preparation.                                           have remained in “doubtful” category

     for more than one year but upto 3 years              Thus, banks could potentially face a large
     will attract a provision of 40 per cent (as          liquidity risk. It is, therefore, felt prudent to
     against the existing 30 per cent);                   place certain limits on banks’ investments
•	   restructured	 accounts	 classified	 as	              in DoMFs. Accordingly, it is proposed:
     standard advances will attract a                     •	   that	 the	 investment	 in	 liquid	
     provision	 of	 2	 per	 cent	 in	 the	 first	              schemes of DoMFs by banks will
     2 years from the date of restructuring,                   be subject to a prudential cap of
     or in cases of moratorium on payment                      10 per cent of their net worth as on March
     of interest/principal after restructuring,                31 of the previous year. However, with
     for the period covering moratorium                        a view to ensuring a smooth transition,
     and 2 years thereafter (as against                        banks which are already having
     existing provision of 0.25-1.00                           investments in DoMFs in excess of
     per cent, depending upon the category                     the 10 per cent limit, will be allowed
     of advances); and                                         to comply with this requirement in six
•	   restructured	 accounts	 classified	 as	                   months’ time.
     non-performing      advances,      when
     upgraded to standard category will                   Presence of Foreign Banks in India
     attract a provision of 2 per cent in the             113.    It was indicated in the Monetary
     first	year	from	the	date	of	upgradation	             Policy Statement of April 2010 that drawing
     (as against existing provision of                    lessons from the crisis, a discussion paper
     0.25-1.00 per cent, depending upon the               on the mode of presence of foreign banks
     category of advances).                               through branch or wholly owned subsidiary
111.    Detailed guidelines in this regard                (WOS) would be prepared by September
will be issued separately.                                2010. Accordingly, a discussion paper on
                                                          presence of foreign banks in India was
Investments in Debt oriented                              placed on the Reserve Bank’s website in
Mutual Funds                                              January 2011 soliciting views/comments
                                                          from all stakeholders, including banks,
112. It has been observed that banks’                     non-banking	 financial	 institutions,	 and	
investments in liquid schemes of debt                     the public at large by March 7, 2011. The
oriented mutual funds (DoMFs) have grown                  comprehensive guidelines on the mode of
manifold. The liquid schemes continue to
                                                          presence of foreign banks in India are being
rely heavily on institutional investors such
                                                          formulated, keeping in view the suggestions/
as commercial banks whose redemption
                                                          comments on the discussion paper, received
requirements are likely to be large and
                                                          from all concerned.
simultaneous. DoMFs, on the other hand,
are large lenders in the over-night markets
                                                          Licensing of new Banks in the
such as collateralised borrowing and lending
                                                          Private sector
obligation (CBLO) and market repo, where
banks are large borrowers. DoMFs invest                   114.   Following the announcement made
heavily	 in	 certificates	 of	 deposit	 (CDs)	 of	        by the Hon’ble Finance Minister in the
banks.	Such	circular	flow	of	funds	between	               Union Budget 2010-11 and as indicated in the
banks and DoMFs could lead to systemic                    Monetary Policy Statement of April 2010, the
risk in times of stress/liquidity crunch.                 Reserve Bank released a discussion paper

on licensing of new banks on its website              which would cover, among others, effective
in August 2010, seeking views/comments                governance of compensation, alignment of
of banks, NBFCs, industrial houses, other             compensation with prudent risk-taking and
institutions, and the public at large. The            disclosures for whole time directors/chief
discussion paper reviewed the international           executive	 officers	 as	 well	 as	 risk	 takers	 of	
and Indian experience on various issues and           banks. Accordingly, draft guidelines on
also indicated possible approaches with the           sound compensation policy were framed
pros and cons of each of the approaches.              and placed on the Reserve Bank’s website
Detailed discussions were held with various           in July 2010 for public comments. A large
associations of stakeholders from the                 number of comments/suggestions were
industry, banks, NBFCs, and MFIs and some             received on the draft guidelines and it was
consultants in October, 2010. In addition,            proposed in the Second Quarter Review
diverse comments, including relating to               of Monetary Policy for 2010-11 to issue
granting of banking license to industrial             final	 guidelines	 on	 compensation	 practices	
houses/business houses have been received             by end-December 2010. However, in
from a large number of respondents, which             October 2010, the BCBS brought out
include parties interested in setting up              a consultative paper titled ‘Range of
new banks, industry associations, banks,              Methodologies for Risk and Performance
academia, eminent personalities associated            Alignment of Remuneration’, for public
with	banking	and	finance,	and	the	members	            comments. As the paper provides guidance
of the general public. Certain issues, which          on important methodological issues, it has
would require amendments to the Banking               been	 decided	 to	 await	 the	 final	 version	 of	
Regulation Act, 1949, have also been                  this paper for formulating our guidelines.
brought to the notice of the Government of            Accordingly, the implementation of the
India. A gist of comments on various issues           Reserve Bank guidelines on compensation
received from important stakeholders and              policy has been deferred till 2012-13.
eminent people on the discussion paper was            This	 will	 also	 give	 sufficient	 time	 to	
placed on the Reserve Bank’s website in               banks to formulate their policies. Banks,
December 2010. All these comments have                in the meantime, should refer to the
been examined and the draft guidelines on             BCBS consultative paper on ‘Range of
the	entry	of	new	banks	are	being	finalised	in	        Methodologies for Risk and Performance
consultation with the Government of India.            Alignment of Remuneration’ of October
                                                      2010, and begin the preparatory work.
compensation Practices
                                                      convergence of Indian Accounting
115. It was indicated in the Second
                                                      standards with International Financial
Quarter Review of October 2009 that in
                                                      Reporting standards
line with the steps taken by the global
community, particularly the initiatives taken         116.   As indicated in the Second Quarter
by G-20 nations, the Reserve Bank would               Review of November 2010, a Working
issue guidelines to private sector banks              Group (Chairman: Shri P. R. Ravi Mohan)
and foreign banks with regard to sound                was constituted in July 2010 to address
compensation policy. It was proposed to issue         the implementation issues and facilitate
comprehensive guidelines based on the FSB             formulation of operational guidelines
principles on sound compensation practices,           in the context of convergence of Indian

Accounting Standards with the International            of a depositor education and awareness
Financial Reporting Standards (IFRSs). Six             fund; facilitating consolidated supervision;
sub-groups, constituted under the aegis of             and a provision for supersession of boards
this Working Group, are closely monitoring             of directors by the Reserve Bank; and
the developments at the international                  increase in the quantum of penalties. The
level, especially the progress made by                 proposals relating to the amendment of
the International Accounting Standard                  the Banking Companies (Acquisition &
Board	 (IASB)	 in	 finalising	 the	 accounting	        Transfer of Undertakings) Act, 1970 & 1980
standards	relating	to	financial	instruments,	          include raising the authorised capital of
and fair value accounting, among others,               nationalised banks; enabling them to raise
and attempting to prepare operational                  capital through “rights issue” or by issue of
guidelines within the framework of IFRS                bonus shares; and raising the restrictions
for the Indian banking sector. The Ministry            on voting rights. These amendments will
of Corporate Affairs placed on its website             have implications for the regulation and
35 Indian Accounting Standards (IND AS),               supervision of various types of banks by the
converged with IFRS in February 2011. It               Reserve Bank.
also stated that it would implement them
in a phased manner after various issues,               Introduction of Bank Holding company/
including tax related issues, were resolved            Financial Holding company structure
with the concerned departments. The                    in India
Reserve Bank is also endeavouring towards              118.     In pursuance of the announcement
skill development at the level of banks and            made in the Monetary Policy Statement of
supervisors with a view to ensuring smooth             April 2010, a Working Group (Chairperson:
and non-disruptive migration to the IFRS.              Smt. Shyamala Gopinath) was constituted
                                                       to examine the introduction of a holding
Amendments to the Banking                              company structure for banks and other
Regulation Act, 1949                                   financial	entities	together	with	the	required	
117.     A comprehensive legislation for               legislative and regulatory framework. The
the amendment of the Banking Regulation                Group is expected to submit its report by
Act, 1949 and the Banking Companies                    end-May 2011.
(Acquisition & Transfer of Undertakings)
Act, 1970 & 1980 was introduced in the                 Information technology and Related
Parliament in March 2011. The important                Issues: enhancement to the Guidelines
amendments relating to the Banking                     119.    A Working Group on Information
Regulation Act include insertion of a                  Security, Electronic Banking Technology
new section to override the provisions of              Risk Management and Cyber Frauds
the Competition Act, 2002 and exempt                   (Chairman: Shri G. Gopalakrishna) was
the applicability of such provisions to                set up by the Reserve Bank to strengthen
amalgamations/reconstitutions/mergers/                 the Reserve Bank’s guidelines relating to
acquisitions, etc. of different categories of          the governance of IT information security
banks; removal of the restrictions on voting           measures, apart from enhancing independent
rights; enabling banking companies to issue            assurance about the effectiveness of IT
preference shares subject to regulatory                controls. The report, which was submitted
guidelines by the Reserve Bank; formation              by the Group in January 2011, covers

various areas such as IT governance,                   products, processes, strategies and risk
information security (including electronic             management techniques at the institutional
banking channels like internet banking,                level. In the recent period, banks have
ATMs, cards), IT operations, IT services               also	 emerged	 as	 financial	 conglomerates	
outsourcing, information system audit,                 in order to exploit economies of scale and
cyber frauds, business continuity planning,            scope. In view of the widening gap between
customer education and legal issues. The               growing supervisory responsibilities and
report was placed on the Reserve Bank’s                available supervisory resources, it was
website for public comments/feedback.                  considered expedient to conduct a review
Keeping in view the feedback/comments                  of the supervisory processes followed
received, detailed guidelines are being issued         by the Reserve Bank. A High Level
to banks. While major recommendations                  Steering Committee (Chairman: Dr. K. C.
of the Group are to be implemented by                  Chakrabarty) was set up by the Reserve
banks within a period of six months, other             Bank to review the existing supervisory
recommendations/guidelines are required                processes in respect of commercial banks
to be implemented within a period of one               in India. The Committee, among others,
year from the date of issue of the circular.           will include a leading industry expert,
                                                       one sitting and one retired chairman and
supervisory Policies, Procedures and                   managing director (CMD) of public sector
Processes: A comprehensive Review                      banks as members. The Committee will lay
120. The operating environment with                    down the terms of reference for review of the
regard to supervision of banks has undergone           supervisory processes in the Reserve Bank
significant	 changes	 with	 considerable	              and select one domestic or international
increase in size, number and complexities of           agency for reviewing the supervisory
banks’ businesses over the last decade. There          processes and giving its recommendations
have	been	extensive	innovations	in	financial	          for implementation.

                           VI. Institutional Developments
non-Banking Financial companies                        A	need	was,	therefore,	felt	to	reflect	on	the	
Review of the Existing Regulatory                      broad principles that underpin the regulatory
Framework for NBFCs                                    architecture for NBFCs, keeping in view the
                                                       economic role and heterogeneity of this sector
121.	 There	 has	 been	 significant	                   and the recent international experience. The
transformation in the NBFC sector in India             Reserve Bank has constituted a Working
in the past few years and the sector has come          Group (Chairperson: Smt. Usha Thorat) to
to be recognised as a systemically important           examine a range of emerging issues pertaining
component	 of	 the	 financial	 system.	 The	           to the regulation of the NBFC sector. The
recent	global	financial	crisis	has	highlighted	        Group	will	also	focus	on	the	definition	and	
the risks arising from the non-banking                 classification	 of	 NBFCs,	 keeping	 in	 view	
financial	sector	because	of	regulatory	gaps,	          the need for addressing regulatory gaps and
arbitrage and systemic inter-connectedness.            regulatory arbitrage, maintaining standards

of governance in the sector and adopting             imposed on such prepaid instruments.
appropriate approach to NBFC supervision.            Considering the potential of such
The Committee is expected to submit its              mobile-based prepaid instruments for
report by end-June 2011.                             promoting non-cash based transactions
                                                     and the interest evinced by non-bank
Setting up of Central Electronic Registry            entities in promoting these products, it is
under the SARFAESI Act, 2002                         proposed:
122. The Government of India has set                 •	   to	 treat	 mobile-based	 semi-closed	
up a company, incorporated under section                  prepaid     instruments     issued by
25 of the Companies Act, 1956, as the                     non-banks on par with other semi-
Central Registry of Securitisation Asset
                                                          closed payment instruments and raise
Reconstruction and Security Interest of India
                                                          the limit from `5,000 to `50,000,
(CERSAI) to give effect to the provisions
                                                          subject to certain conditions.
of the Securitisation and Reconstruction
of Financial Assets and Enforcement of               125. Banks were permitted by the Reserve
Security Interest (SARFAESI) Act, 2002.              Bank in December 2009 to provide their
The objective of the central registry is             customers the mobile-based transaction
to prevent frauds in loan cases involving            facility up to `1,000 without end-to-end
multiple lending from different banks on             encryption. Taking into consideration the
the same immovable property. The registry            feedback from banks for increasing the
became operational from March 2011 and               limits for such transactions, it is proposed:
its jurisdiction covers the whole of India.          •	   to	enhance	the	limit	of	such	transactions	
                                                          from `1,000 to `5,000.
Payment and settlement systems
                                                     Working Group for Card Present
Mobile Banking in India                              Transactions
123. Considering        the     importance           126. Card         present        transactions
of mobile phone channels for banking                 [transactions at points of sale (PoS) and
services, the Reserve Bank issued                    ATMs] constitute a major proportion of
guidelines on mobile banking in October              the card based transactions in the country.
2008. Since then a number of relaxations             For	increasing	the	confidence	of	customers	
in the guidelines have been made. In all,            in this channel, it is necessary to secure
39 banks were granted approval for mobile            these transactions through implementation
banking, of which 34 banks have launched             of additional security/authentication in
the mobile banking services. On an                   the short run and prevent counterfeiting
average, 6,80,000 transactions amounting             of cards by migrating to chip-based and
to `61 crore in a month are settled through          PIN-based cards in the long run. Considering
this channel.                                        the importance of this process, a Working
124. Non-bank entities were permitted                Group comprising representatives from
by the Reserve Bank to issue mobile-                 various stakeholders was constituted
based semi-closed prepaid instruments                to recommend action plan for enabling
in August 2009. To start with, these                 additional authentication for transactions
instruments were considered as a separate            at PoS using existing cards in a cost
category and a cap of `5,000 was                     effective manner and propose a timeframe

for migrating the card infrastructure to               moving forward from their core banking
enabling issuance and acceptance of                    solutions to enhanced use of IT in areas
chip-based and PIN-based cards. The                    such as management information system
Working Group is expected to submit its                (MIS), regulatory reporting, overall
recommendations by end-May 2011.                       risk	 management,	 financial	 inclusion	
                                                       and customer relationship management.
Performance of National Electronic
                                                       The recommendations related to both the
Funds Transfer System
                                                       Reserve Bank and commercial banks. The
127.	 All	 the	 refinements	 to	 the	 national	        Reserve Bank has drawn a roadmap for
electronic funds transfer (NEFT) have                  implementation of the vision document
been well accepted by the stakeholders                 over short-term (2 years), medium-term
and the product is growing from strength               (2-4 years) and long-term (4 years and
to strength in terms of acceptability, reach           more). The Reserve Bank will, in
and volumes handled. As at end-February                association with the Indian Banks’
2011, around 75,000 branches of 100 banks              Association (IBA), follow up on
participated in the NEFT system and the                implementation of the recommendations by
volume of transactions processed increased             commercial banks.
to 13.5 million in February 2011. Efforts
have also been initiated to extend NEFT                Automated Data Flow from Banks
facility to the branches and customers of
                                                       129. A Core Group consisting of experts
RRBs. A few banks have since successfully
                                                       from banks, the Reserve Bank, the Institute
and seamlessly brought the RRBs
                                                       for Development and Research in Banking
sponsored by them under the NEFT ambit.
                                                       Technology (IDRBT) and the IBA was
Further, full assistance was provided to
                                                       constituted for preparing an approach paper
the Royal Monetary Authority of Bhutan;
                                                       on	automated	data	flow	(a	straight	through	
the electronic clearing service (ECS) and
                                                       process) from the core banking solution
the NEFT were successfully replicated in
                                                       (CBS) or other IT systems of commercial
                                                       banks to the Reserve Bank. It was indicated
                                                       in the Second Quarter Review of November
It Vision Document for 2011-17
                                                       2010	 that	 the	 Core	 Group	 had	 finalised	
128. A        High    Level    Committee               the approach paper and the timeline of
(Chairman: Dr. K. C. Chakrabarty) was                  the entire project would be determined in
constituted by the Reserve Bank to prepare             consultation with banks. It has been decided
an IT vision document for the period                   to implement the project in a phased manner
2011-17, taking into account requirements              taking into account the technology and
and expectations of the banking system in              process maturity of individual banks. Banks
general and those of the Reserve Bank, in              have been advised to submit a roadmap
particular. The report of the Committee                clearly indicating the returns which can be
was placed on the Reserve Bank’s website               sourced directly from the banks’ systems
in February 2011. The document contained               for submission to the Reserve Bank without
a number of recommendations, including                 manual intervention. It has also been
the Reserve Bank transforming itself                   decided to prescribe a quarterly monitoring
into an information intensive knowledge                format in which the banks will be advised
organisation and commercial banks                      to certify the list of returns which have been

internally generated from the IT source            sorting machines in all their branches
systems without manual intervention. The           having average daily cash receipts of
Reserve Bank is in touch with the banks            `1 crore and above by March 2010. As of
and the solution providers for implementing        now, 1,323 branches (other than currency
the recommendations over a period of two           chest	branches)	have	been	identified	having	
years.                                             average daily cash receipt of `1 crore
                                                   and above. Banks have reported that note
Real time Gross settlement system                  sorting machines have been installed and
130. As indicated in the Monetary Policy           made operational in 1,012 branches. For
Statement of April 2010, a Working Group           the remaining branches, banks have made
was constituted for preparing an approach          arrangements with the nearest currency
paper for implementing the next generation         chest branch/currency administration
real time gross settlement (NG-RTGS)               branch. It was also indicated in the Second
system. The Group has since submitted the          Quarter Review of October 2009 that
approach paper, the suggestions of which           banks should use such machines in all
have been taken as a basis for preparing           their branches having average daily cash
the blueprint for the NG-RTGS system.              receipts between `50 lakh and `1 crore
First, the Reserve Bank has initiated steps        by March 2011. Banks have reported that
to enhance the capacity of the hardware                                                         	
                                                   they	 have	 identified	 3,000	 branches	 with	
system in the short-term by rationalising          daily cash receipt between `50 lakh and
the use of the resources during peak               `1 crore, out of which 413 branches have
and non-peak periods. Second, the                  installed note sorting machines. Another
process for enhancing the capacity in the          517 branches have put in place arrangements
medium-term has already begun. Third,              for processing of high denomination notes.
several new features are being envisaged           Banks are expected to enhance their efforts
in the NG-RTGS system such as advanced             to have note sorting machines in all such
liquidity management facility; extensible          identified	branches.
mark up language (XML) based messaging
system conforming to ISO 20022; and real           second Quarter Review
time information and transaction monitoring
                                                   132. The       next   review    of    the
and control system.
                                                   developmental and regulatory policies
                                                   will be undertaken as part of the Second
currency Management                                Quarter Review of Monetary Policy on
131.   Banks were mandated to use note             October 25, 2011.

May 3, 2011


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