Reforms in Financial

Sector

Group 10
Shraddha Dixit | Gauri Patil| Ghazal Afreen | Oshin Doley | Tanya Trivedi
Introduction
Elements Of Financial Sectors
 Financial sector is the mainstay of any economy and
it contributes immensely in the mobilization and
distribution of resources.

 Financial sector reforms have long been viewed as

significant part of the program for policy reform in Financial
developing nations. Banks
Institutions

 The economic reforms occurred amidst two serious

crisis: BOP crisis in financial sector and threat of
insolvency concerning the banking sector.

 The 1991 LPG reforms happened in almost all the Instruments Markets
sectors of the economy, but it was not at the same
rate.

 Financial sector, which serves as an instrument for

economic development was the most laggard of all
the areas in terms of reforms.
• Is the current strategy for financial sector reforms needs to reviewed?

• India managed to escape with relatively small damage from the devastating impact
of the two financial crisis of 1929 and 2008 that had on the rest of the world.

Role of Financial Sector

 Widely accepted that growth and diversification of financial institutions helps in the
economic development.

 The reforms introduced has significantly widened the range of institutions:

 MFs
 NBFCs
 Private sector banks
 Modern brokerage houses, both in stock and commodity markets
 Life and General Insurance companies
Recommendations of Major Committee
Tarapore-I Raghuram Rajan Tarapore- II R. H. Patil Percy Mistry
Committee Committee Committee Committee Committee
(1997) (2008) (2006) (2005) (2007)
• Objective: Study • Central Bank • Review CAC in • Objective: to • Mumbai as the
the implications should target light of current recommend International
of full Capital Inflation economic road map for Financial
Account • Setting up reforms Corporate Debt Centre
Convertibility Financial • Reduction of Market • Set up four
• A three year Stability and fiscal deficit • Development of different
time frame for Development • Ceilings for primary market regulators, one
complete Council ECB’s should be by addressing each for
convertibility by • Steady opening raised for issue of banking, capital
1999-2000 up of rupee automatic differential markets,
• Removal of tax bond market approval stamp issue, pension and
benefits to • A liberal • NRI’s should be TDS rules for insurance
NRI’s approach on able to invest in corporate bonds • Moving from
• Greater outflows, with capital markets • Retails entity based
autonomy to the timing being and deposits investors to regulation to
RBI critical given tax participate in domain based
• Complete check • SEBI should be benefits bond market regulation
on fiscal deficit regulator of all • Banning of • Trade Reporting • Privatization of
• Reduction of trading Participatory System to banking sector
government activities Notes capture all and lesser state
stake in banks information control
Preconditions for CAC
Balance of Foreign exchange
Fiscal Deficit Inflation
Payment reserves
• Target was to • 2008-09: Trade • Actual inflation rate • Contributed by
achieve 3.5% of deficit was ~10% of was close to short-term FII &
GDP GDP desirable level ECBs
• 2009-10: ~12% • Financed by • But, inflation • Not sustainable; as
it doesn’t rely on
• Unlikely to achieve software exports measured by CPI BoP or FDI
indicated trouble

India towards full CAC

 Daily transactions in foreign exchange markets is ~US$ 3 trillion

 India’s current level of foreign exchange reserves stands with below US$ 0.3 trillion
 Too high risk of removing controls on capital accounts and have speculative capital
inflows/outflows
Approach to Capital Flow & Convertibility
Current scenario

 Annual growth rate of 9% during 2007-08 but unappreciable unemployment growth

 Delays in liberalization of policies and procedures in the area of FDI
 Large short-term capital inflows and outflows causing disturbances to formulation of monetary
policy and exchange rate management by the RBI
 Leads to fluctuations towards appreciation of rupee affecting profitability and employment
of exporting industries as also import-substituting industries
 Indian equity markets:
 Have become highly volatile, especially after hedge funds were allowed direct entry
through Foreign Institutional Investors Route
 Investment bankers issued Participatory (P)-Notes to unknown entities abroad whereas
Indian investors had to prove his/her bona fides by satisfying KYC requirements
Approach to Capital Flow & Convertibility
Current scenario
SENSEX NIFTY
100%
80%
60%
40% 76%
55%
20%
0%
(20%)
(52%)
(40%)
(60%)
2007 2008 2009
Source: http://store.ectap.ro/articole/698.pdf

HEDGE FUNDS
Approach to Capital Flow & Convertibility
Recommendations

 Significant FDI in industry and infrastructure sectors to help the economy grow at >10%
 Prevention of unemployment, through policies by RBI, caused by sudden appreciation of rupee
 Placing rupee depreciated to selected basket of currencies to provide incentives for industries
 Adoption of a Hierarchy Order for capital inflows:

Long-term direct
Bring durable inflows of capital besides increasing employment and GDP
investments

Long-term debt to
Long-term debt provides sufficient support to deal with solvency
Short-term debt

Preference to industries that augment foreign exchange earning

FDI
capabilities of the country, either directly or indirectly
Approach to Capital Flow & Convertibility
Recommendations

Governance of Equity Markets:

 Prohibition of FIIs from investing in fresh P-notes along with immediate ban on P-notes and
gradual winding-up of existing ones
 Discouragement of flowing of billions of speculative funds into the country to avoid high
volatility in the market
 Reframing of policy regarding inflows of portfolio foreign investments to encourage genuine
long-term investors
 Preference to investors like foreign pension funds, mutual funds, university endowment funds,
and similar bodies
 Routing all investors through bank entities which ensure compliance with KYC requirements
 Special regulation by SEBI to help government identify and ban large global speculators
Approach to Capital Flow & Convertibility
Indian rupee

Indian Foreign
Direct Investments
Approach to Capital Flow & Convertibility
Foreign Portfolio Investment Total FDI Equity Inflows

Source:
1. https://www.ceicdata.com/en/indicator/india/foreign-portfolio-investment
2. https://community.data.gov.in/total-foreign-direct-investment-equity-inflows-from-2000-01-to-2016-17/
Banking Sector Reforms

• Low access to organized finance

• The portion of people in India who are “banked”
rose from 35 percent to 53 percent between 2011
Problems and 2014, according to the World Bank-Gallup
Global Findex Survey 2014
• Failure of Cooperative entities due to political
intervention

• Increased network of public sector and private

sector banks
Solutions
• Replacing Regional Rural Bank model with
commercial banking model
Concept of Small Banks

 Rajan Committee:

• 59 Recommendation – Small finance banks will be a new set of institutions with

their own pattern of ownership and voting rights, board, governance structure,
regulatory requirements etc.

 Exclusive Regulatory jurisdiction of RBI provides for

• Eliminating influence of politicians

• Ensuring that they fulfil their objectives
Requirements of Small Banks

Fit and proper criteria for all directors

Majority Independent directors

Cost efficient IT solutions like Core Banking System

Capital of at least Rs.200 crore

Should be essentially like Regional area banks

Advantages of Small Banks
 Main motivation is Financial Inclusion to reach out to unserved and undeserved segments

 Offer all commercial banking services at a smaller scale and at low transaction cost

 Can give 75% of their total credit to priority sector which includes those working in
agriculture, small enterprises and low-income earners

 Can distribute third party products like mutual funds, insurance and pension products
Banking Sector Progress
Growth in Individuals’ Savings Bank
Deposits Accounts with SCBs
In Millions

Source: https://rbi.org.in/scripts/PublicationReportDetails.aspx?ID=836#CH1
Small Banks licensing
 Country needs to be divided into 6 to 8 geographical divisions

 Consider 4 to 5 candidates for granting licences

 Licences in each division should be granted to different promoters like NBFCs or industry
houses to ensure enough competition

 Bait offered to small banks would be to allow them to grow out of their region and become
national banks after showing satisfactory performance

 RBI needs to bear the higher cost and carve out a special wing for supervising small finance
banks
Rethink One-Size-Fits-All Approach
 RBI has gathered deep knowledge about the functioning of banks under different types of
managements, geographies, and economic cycles.

 Tighter onsite inspection of banks and concurrent audit of not so well governed banks to avoid
financial disasters and corporate governance issues

 3 onsite inspections of new small finance banks covering multiple areas

 Tarapore-II Committee recommendation -> Permit new strong private sector banks

 Valuation game like in the mutual fund industry which helps promoters make large gains
should be prohibited in the Banking industry

 Entry into big banks should be limited to large players.

 Initial capital requirement = Rs 1000 crore

 Dilution of promoter’s holding within a reasonable period of 5 years

Single Objective Monetary Policy

 Argument – Should RBI have a single objective for monetary policy of controlling inflation ?

 RBI has multiple policy objectives

1. Exchange rate management
2. Management of Government borrowings
3. Maintaining macroeconomic stability
4. Development of financial sector and larger economy

 Rajan Committee Argument – RBI main policy objective should be to control inflation

 However, No recommendations from the committees to the GOI to change RBI’s mandate

 Monetary policy alone is not efficient to control inflation since records show that inflation at
many times has been on account of supply factors
Unification of Market Regulations
Mistry Committee

- favours single super- regulator as Financial Service Authority in the UK

Advantages:

 Solve problems arising from inter-regulatory difference

Disadvantages:

 UK created major regulatory gap by taking regulation away from BoE & giving to FSA

 FSA failed to detect major problems in banks as Royal Bank of Scotland, northern rock
band

 FSA failed to realise the asset bubble building in UK’s property market
Unification of Market Regulations
Rajan Committee

- favours bringing regulation of organised of trading in government bonds, currencies,

equities, corporate bonds and commodities under SEBI

Advantages:

 Benefit by economies of scale. Same set of clients/dealers, similar risk management etc

Disadvantages:

 No perceptible cost of reduction due to modern IT dominating practices

 Lack of specialization in knowledge and expertise building in single regulatory

organisation
Regulation of Government Securities
Government Securities (Current Scenario)
• RBI acts as repository
• RBI sole merchant banker managing all issues of GoI and state gverment
• CCIL managed government securities by RBI
• Government intervenes in buying government securities, sometimes
• Argues that RBI cannot perform its function its functions satisfactorily

Argument is to transfer G-sec regulation to SEBI

• Combined budgetary deficit of state and central goverment is 12% of GDP
• G-sec will remain in a delicate balance until fiscal deficit & outstanding
stock govt debt comes down to very low level
• Market can not be left to vagaries of free market forces Why
• If transferred, NDS to be dismantled, NOT?
• G-sec primary issues might fail
• Not feasible at current juncture, as several legislative amendments to be
made
• Acamdic in nature at current point
Trading in currency
It can not be transferred to SEBI as
• Country not ready for freely fluctuating exchange rates
• Exchange rate of rupee is influences all other commodities & product Why
prices and interest rate hence is very important for economy NOT?
• Influences cost competitiveness of software, IT enabled services,
agriculture, mining etc
• Can not be left to vagaries of speculative forces as recommended by free
market protagonists

Commodity markets
Can not be transferred from forward market commission to SEBI Why
• SEBI does not have necessary expertise NOT?
• Decisions related to eligibility of suture trading, commodity specific rules
and regulations needs expertise
Corporate Bond Market
Why Corporate bond is required?
• A well developed corporate bond market can meet substantial part of funding requirement
of infrastructure

• To meet requirement of pension and provident fund

Recommendations by Patil Committee:

• Stamp duties should be brought down for encouraging companies to issue bond: Central
government needs to pursue the ECSFM, Government will get some revenue

• Revision of primary issue mechanism followed, which minimises the current hassle of
public issue requirement

• Adoption of a rating based issue system so issue system can be simplified

• Removal of unnecessary restriction that are placed on the issuance and tradability of
securitised instruments issued by special purpose vehicle
Corporate Bond Market

Source: https://www.ccilindia.com/Documents/Rakshitra/2012/June/Article.pdf
Financial Stability and Development Council
• Apex-level body constituted by the government of India
• Idea to create such a super regulatory body first mooted by the Raghuram Rajan Committee
in 2008

Composition Responsibilities

Chairperson: The Union Finance Minister of • Financial Stability

India
Members:
• Governor Reserve Bank of India (RBl)
• Finance Secretary and/ or Secretary, DEA
• Secretary, DFS, Ministry of Corporate
Affairs
• Chief Economic Advisor, Ministry of Finance,
• Chairman, SEBI, IRDA, PFRDA, IBBI
• Financial Sector Development
• Inter-Regulatory Coordination
• Financial Literacy
• Financial Inclusion
• Macro prudential supervision of the
economy
• Coordinating India's international
interface
Disappearance of Term-Lenders
• There is a need for the country to find its own solution for funding viable large industrial and
infrastructure projects.
• China: Banks to provide finance
• India: Large developmental Institutes

Prior to 1990 After 1990 reforms

 Development banks had access to long-  Government dismantled these special
term debt arrangements

 Were supported by Government directly  Developmental banks were denied

and indirectly access to deposit market
 As they didn’t maintain CRR or
 Were directed by GoI to lend at interest SLR with RBI
rates much lower than what banks  Liquidity couldn’t not ensured for
charged for working capital loans deposit market

 Were given budgetary support, as also a  These banks were forced to convert into
quota of Govt. guaranteed bonds each commercial banks
year.
Disappearance of Term-Lenders
 Indian Infrastructure Finance Company Limited (IIFCL) was constituted to take the
activities earlier undertaken by the development banks

Issues Wasn’t capable of addressing these issues as lacked domain knowledge

Large projects require highly complex and specialised appraisal skills

Relied entirely on the expertise of the new consortium leaders of SBI, Axis
bank and IDFC
Emergence of REC and PFC
PFC and REC emerged as major lenders to power projects

Issues:

 Part of bureaucratic framework

 Intrinsically Non-performing portfolio which cannot be declared NPA

 Lending narrowly focussed on the power sector, sectoral diversification missing

 Exempted from following guidelines regarding income recognition, asset classification, and
provisioning

Concerns regarding the evolution of these entities on the lines of State Finance Corporations.
Arguments against FSDC

•As the finance minister is leading the FSDC

Politicization

•That all decision making, even day to day matters will be done by this apex body, the secretariat of which will
be the Union Ministry of Finance
Perception •This will lead to dilution of authority of other regulators and affect their response time

•For many resourceful market players to work through their lobbies at the finance ministry secretariat
Temptation
•Lead to corruption.

•Other regulators, jealous of RBI’s current status may be tempted to overplay their hands at the FSDC
Overplay
meetings

It may evolve as a super regulator and undermine the authority of all other regulators in the
financial sector.
Arguments against FSDC
Under the proposed structure, RBI’s autonomy will get compromised.

Roles of RBI:
 Nurtured variety of institutions
 Played major role in financial sector diversification
 Played major role in setting up of nation-wide network for development bank institutions
 Helped in launching the mutual fund movement in India
 Because of special status, has been able to build a professional cadre of its own
HLCC on financial markets
Comprising: Chiefs of RBI, SEBI, Pension Fund Regulatory and Development Authority
(PFRDA), and Insurance Regulatory and Development Authority (IRDA)

Expectation: Resolve any issues that may arise whenever there are possibilities of
regulatory conflicts.

Case of ULIPs: After almost a decade of selling ULIPs, SEBI banned 14 life insurance
firms from issuing fresh ULIP schemes.

Reasons:
1. ULIP happened to act as mutual funds, which are subject to SEBI
2. ULIPs also account for 50 per cent and more of the life insurance business and the money
collected through them is invested in equities

Result: The committee which was conceived as purely consultative forum, was unable to
resolve the issue.
Financial Sector Legislation
Recommendation to set up Financial sector legislative Reforms
Commission to:

1. Rewrite and clean up the statutes

2. Decrease the complexity due to large number of amendments
3. Redistribute powers among regulators so that the financial sector develops along more
rational lines e.g. to transfer regulation of the foreign exchange market, government
securities market and the commodity future market to SEBI from RBI

• Information needed by the single expert group on Govt.’s considered decisions to be adopted
in the draft bill, e.g. concentrating all market regulatory powers in the hands of SEBI.

• Concerns regarding the limited attention the finance ministry could give to legislative
matters when there are so many day-to-day concerns to be addressed
Insolvency and Bankruptcy Code

 Bankruptcy is a financial  Industrial companies Act

condition where a and SARFESI Act have
firm/individual is unable failed to address the
to repay debts to
problem
creditors.
 Bankrupt entity is a
debtor adjudged as  The WB’s Doing Business
bankrupt by an Report 2016 pointed out
adjudicating authority that it takes more than
through passing a four years to resolve
bankruptcy order
insolvency cases in India,
and one-and-a-half years in
OECD’s countries
 Address the crisis of
NPAs in banking  IBC will take care of new
sector business units, jobs, income
 Improve the climate generation as well as
of entrepreneurship greater availability of
credit for businesses by
 Enable the corporate
freeing up capital, thereby
and infrastructure boosting innovation and
bond market productivity
Conclusion
 Financial sector instruments are facilitators of economic development of other sectors by
providing efficiency enhancing services to them and not appropriating their wealth. This
needs to be considered while drafting financial sector reforms

 CAC is not and end in itself but a means to realise potential of the economy to the
maximum possible extent at the least cost

 Speculators are not merely guided by the economic fundamentals of a country

 For overall growth of the economy, the need is of a comparatively irreversible resource
infusion in the infrastructure and industrial sector.

 Our policy objective should be such that unemployment levels in exporting and import
substituting industries caused by sudden appreciation of rupee is avoided.

 Long term borrowing should always be favoured over short term, and even in that,
preference should be given to industries that augment foreign exchange earning capabilities
of India either directly or indirectly
Conclusion
 Policy by SEBI on regulation of firms issuing P-notes needs to address the high volatility
created in Indian market.

 Regional rural banks and cooperative banks have performed badly in the field of financial
inclusion and alternate options need to be explored e.g. small finance banks with strong
credentials and closely supervised by RBI

 Instead of relying on international norms, RBI needs to place greater emphasis on its own
experience

 Specialised regulator is better able to monitor as well as handle adverse situations

 There is a need of a well developed corporate bond market

 A suitable regulatory and tax framework is required that is conducive to attracting

investments into specialised long term funds intended for large infrastructure projects

Markets are not going to be the solution to all our problems

A broad-based industrialization and infrastructure development is needed to pull the masses of

population above poverty line and in this, financial sector should clearly serve as an instrument.
Thank You