Financial sector regulatory reforms in India are being driven by a commitment to global regulatory standards as
also domestic priorities. While the ownership structure and recapitalisation of public sector banks are contingent
upon government policy and the fiscal situation, there is a strong case for subjecting them to the requirements of
market discipline.
India’s ‘shadow banking’ sector essentially refers to the large number of ‘unregulated’ entities of varying sizes and
activity profiles, raises concern partly because of the public perception that they are regulated. Technology aided
innovations in financial disintermediation such as peer-to-peer lending warrant a regulatory preparedness. A
spurt in the activities of asset reconstruction companies (ARCs) driven by banks’ efforts for cleaning up their
balance sheets, calls for a closer look at the extant arrangements between ARCs and banks.
The regulation of securities markets in India is in sync with international developments, though mutual funds
and other asset management activities in Indian markets do not carry risks similar to those experienced in other
jurisdictions. The amount of lending by insurance companies, though small relative to banking sector’s lending,
warrants a coordinated approach on prudential frameworks to eliminate the possibilities of regulatory arbitrage.
Revised norms for corporate governance as also warehouse and related processes are expected to strengthen the
functioning of the commodity derivatives market. In the case of several defined benefit pension schemes, inadequate
liability computation especially in the context of rising life expectancies can be a potential source of fiscal stress in
the years to come.
Global Regulatory Reforms and India’s Stance
3.1 The Financial Stability Board’s (FSB) current
focus is on completing the core aspects of the four
fundamental areas of the G20 led international
financial regulatory reforms: Basel III, ‘too big to fail’,
shadow banking and the derivatives markets.
However, the varied pace of implementation of some
of the reform measures across jurisdictions with hints
of ‘national’ approaches, underscore the need for
adopting and adapting reform measures according to
specific priorities.
Basel III Regulations
3.2 The regulatory push at the global level has
improved banks’ capital ratios1. However, a marginal
improvement in terms of ratios – which are static
measures of capital adequacy, may still not be
interpreted as a move towards substantial strengthening of capital levels in the banking industry.
The previous FSRs discussed issues related to the
possibility of manoeuvring risk-weights, especially
under internal models based approaches for different
types of risks under the Basel framework. The Basel
Committee on Banking Supervision (BCBS) is
addressing the weaknesses in risk measurement by
establishing a closer calibration of the risk model
based approach with the standardised approach2. The
minimum leverage ratio regulation under Basel III
attempts to address this gap but the prescribed value
of 3 per cent is perceived, by some stakeholders to be
too ‘light’ to be effective as a ‘back-stop’.
3.3 The relatively more stringent national
approaches to bank capital regulations in many
jurisdictions, including in the US and the UK, also
indicate the need of going beyond Basel III
prescriptions. This is also evidenced by the increasing importance being accorded to stress tests3 which,
though based on Basel ratios, are in the nature of
conditional dynamic measures with the risk
adjustment occurring in the numerator (capital) at
various points in time throughout the scenario4. Also,
with differences in the features of the business model
and varying compositions of entities and activities
that are present in most jurisdictions, the ‘broadbrush’
approach to capital rules may face challenges
to their effectiveness.
Capital Needs of Indian Banks for Basel III
3.4 The capital to risk weighted assets ratio
(CRAR) for Indian banks under Basel III as at end
March 2014 stood at a comfortable level of 12.9 per
cent, although going ahead, there will be a need for
raising additional capital to comply with the Basel III
requirements. According to some rough estimates5
based on a set of assumptions, Indian banks’
additional capital requirements will be to the tune of `4.95 trillion over the period of phasing in of the Basel
III requirements. This estimate does not include the
impact of comprehensive pillar II capital add-ons
under Basel III which Indian banks have not been
subjected to so far. The Reserve Bank, as part of the
Supervisory Review and Evaluation Process (SREP)
under pillar II of Basel III, may, if required, prescribe
a Supervisory Capital Ratio (SCR) above the regulatory
minimum under pillar I, which banks need to
maintain on an ongoing basis. The Supervisory
Programme for Assessment of Risk and Capital
(SPARC) framework of the Reserve Bank, under the
Risk Based Supervision (RBS) regime, integrates SREP’s
main elements. SPARC aims to adequately capture
and assess all the pillar II risks, including mainly those
arising out of ‘business’, lack of adequate ‘controls’ and ‘governance & oversight’. Estimates of additional
capital requirements are expected to be considerably
higher, especially for PSBs if SCR is considered
(instead of the minimum pillar I regulatory ratios).
Market Valuations of Public Sector Banks
3.5 Even ignoring the component of supervisory
capital requirements, public sector banks (PSBs) are
expected to require additional capital to the tune of
`4.15 trillion over the period of the phasing in of Basel
III, of which equity capital accounts for `1.43 trillion,
while non-equity capital will be of the order of `2.72
trillion. The government’s contribution to PSBs’
equity capital will be of the order of `900 billion at
the existing level of the government’s shareholding.
3.6 Amidst the government’s fiscal position
constraints, PSBs’ ability to raise additional capital
from the market depends on the conditions in capital
markets and the ‘market perception’ of their relative
strengths and weaknesses. The ratio of market price
to book value (P-B ratio) of shares for PSBs is much
lower than those of their private sector counterparts
(Chart 3.1). With the notion of an implicit government
guarantee behind PSBs, their valuations should be
intuitively converging with industry averages, even
after allowing for some differences in operational
flexibility and efficiency vis-à-vis new private sector
banks (NPBs)6. The reasons for this dichotomy need
a detailed examination. A lower P-B ratio could lead
to equity dilution and relatively ‘thinner’ spreading
of earnings per share (EPS) for the same amount of
additional capital raised and the prevailing lower
valuations will cause a sub-optimal price for the
inherent value, if the government intends to divest
a part of its equity stock in PSBs.
3.7 Unlike most other jurisdictions India has not
had any history of a full blown banking crisis and the
episodes of financial instability faced by it in the past
have mostly been in the nature of currency/external
sector crises. While pillar I and pillar II regulations
are important for all banking systems, it needs to be
recognised that in the present Indian context, they
may not be as critical as they might be in other
jurisdictions which have faced banking crises. There
is a need to carefully balance development priorities
with compliance to international regulatory
prescriptions at this stage of evolution of the Indian
financial system.
3.8 At the same time, the Indian banking system
needs an urgent and greater attention towards pillar
III of Basel regulations, i.e., subjecting banks to market
discipline. Swifter progress towards a more robust
emphasis on market discipline will result in better
pay-offs not only for the Indian banking sector but
also for the overall financial system. The time seems
to be ripe for inducing banks, including PSBs, to
approach capital markets – both equity and debt, in
a competitive environment. Beyond a minimum
(regulatory limit) level of equity capital, there is a
need for increasing the role of other kinds of longterm
‘hybrid’ and debt instruments, which if imparted
with certain loss-absorbency features, become eligible
to be counted under additional Tier 1 and Tier 2
capital (for example, perpetual debt, non-cumulative
preference shares and contingent capital instruments).
This will result in improved market discipline by
subjecting the banks to a more intense scrutiny of
their performances.
3.9 The present situation can be used as an
opportunity where demand for long-term funding
driven by regulatory requirements may provide
necessary impetus for making the corporate bond
market evolve to the next level. In this context, the practice of subscribing to equity and debt capital
issuances of public sector entities – both financial and
non-financial, by other public sector entities should
be kept within prudential limits. This will restrict the
extent of cross holding of equity and debt within the
public sector and help in the spreading of risks and
ownership to a wider set of participants and an orderly
progress towards more matured market mechanisms.
Basel III Liquidity Risk Framework for Indian Bank
3.10 BCBS issued the final standards on the Basel
III liquidity coverage ratio (LCR) and liquidity risk
monitoring tools in January 2013. In view of their
implications for financial markets, credit extension
and economic growth, LCR will be introduced in a
gradual manner with effect from 1 January 2015,
beginning with the minimum requirement set at 60
per cent, which will rise in equal annual steps to reach
100 per cent on 1 January 2019. The Reserve Bank
issued its guidelines on LCR, liquidity risk monitoring
tools and LCR disclosure standards in June 20147. The
guidelines take into account the range of high quality
liquid assets (HQLA) available in Indian financial
markets and their liquidity vis-à-vis the liquidity
instruments prescribed in the BCBS standard.
Investment in government securities to the extent of
2 per cent of net demand and time liabilities (NDTL)
- currently allowed under the marginal standing
facility (MSF), is eligible to be included under Level
1 HQLA. While covered bonds, residential mortgage
backed securities (RMBS) and corporate debt securities
(including commercial paper) of rating between A+
and BBB- have not been included as Level 2 HQLA,
eligible common equity shares with 50 per cent
haircut have been allowed to be included as Level 2B
HQLA.
3.11 Banks in India need to maintain the statutory
liquidity ratio (SLR) by investing in specified assets as
prescribed by the Reserve Bank. The present
prescription requires banks to invest a minimum of
22.5 per cent of their NDTL in SLR eligible assets8,
which are essentially government securities. Banks
stay invested in SLR eligible securities, which are akin
to HQLA, not only to comply with statutory
obligations, but also due to other factors such as riskfree
status, a high collateral value and their importance
in accessing central bank liquidity window. Hence,
Indian banks have an adequate liquidity cushion to
the extent that they are required to comply with SLR
stipulations. A quantitative impact study (QIS) carried
out by the Reserve Bank found that most of the banks
satisfied the minimum criteria of LCR of 60 per cent
even with the then SLR stipulation of 23 per cent
(which has been subsequently revised to 22.5 per
cent)9. In these studies, the excess holdings of the
cash reserve ratio (CRR) and SLR and G-Sec holdings
equivalent to 1 per cent of NDTL were considered as
the banks’ HQLA10. Going forward, as the LCR
requirement increases progressively, the Reserve Bank may consider it desirable to further reduce the preemption
of banks’ resources through the stipulation
of SLR in gradual steps, along with a commensurate
decline in the held to maturity (HTM) dispensation11.
Given the roadmap for fiscal consolidation to reduce
fiscal deficit to 3 per cent of GDP by 2016-17 any
decline in incremental availability of government
securities may not thus impinge on SLR and LCR
requirements.
3.12 While the intentions behind supporting these
liquidity mandates may be good, the spill over to
monetary policy formulations along with the
possibility that the regulatory push may force the
financial system towards a short-term market need
to be assessed. The new mandates should not severely
curtail banks’ ability for ‘maturity transformation’,
especially when markets for long-term funds are not
yet developed.
Ending ‘Too-Big-To-Fail’
3.13 Globally, the debate on some of the vital
aspects of the reforms like policy proposals seeking
to limit the size of the banks and/or requiring a
minimum amount of long-term unsecured debt to be
held by the ‘complex’ banks is still not completely
settled. Furthermore, there are challenges being faced
in many jurisdictions where major legislative
measures are needed to fully implement the ‘Key
Attributes of Effective Resolution Regimes for
Financial Institutions’, specifically those related to
the adoption of bail-in powers and other resolution
tools, powers for cross-border cooperation and the
recognition of foreign resolution actions. Certain
structural reform measures (for example, separating
the activities in different entities within the group, intra-group exposure limits and local capital and
liquidity requirements) taken at a jurisdictional/
national level may help in curbing the tendency of
systemically important financial institutions (SIFIs)
to indulge in excessive risk-taking and contribute to
improving their resolvability. However, the divergence
in such structural measures imposed by different
jurisdictions may adversely affect the cause of
integration across national or regional markets and
may result in incentives for regulatory arbitrage.
D-SIB Framework for India
3.14 There is no Indian bank in the list of global
systemically important banks (G-SIBs). While the
competitive structure of the industry has improved
over the last two decades, there is still a significant
degree of skewness in the size of the banks, as
reflected by the fact that the second largest bank in
the system is only around a third of the largest bank
in terms of total assets (on balance sheet). The top 5
banks account for around 35 per cent of the total
assets but none of the banks is seen to be large enough
to becoming a significant global player. Thus, the TBTF
issues being faced in most advanced jurisdictions are
not as critical in the Indian context, though they
remain important in terms of the evolution of the
regulatory framework.
3.15 The Reserve Bank released the draft framework
for identification of the Domestic Systemically
Important Banks (D-SIBs) in December 2013.
Indicators which will be used for assessment are size,
interconnectedness, substitutability and complexity,
with a larger weightage (40 per cent) given to size than
to the other indicators. Based on their systemic
importance scores, banks will be plotted into different
buckets and D-SIBs will be required to have an
additional common equity Tier 1 capital requirement
ranging from 0.20 per cent to 0.80 per cent of the risk-weighted assets. D-SIBs will also be subjected to
differentiated supervisory requirements and higher
intensity of supervision based on the risks that they
pose to the financial system. The computation of
systemic importance scores will be carried out at
yearly intervals and the names of the banks classified
as D-SIBs will be disclosed in August every year
starting from 2015.
Resolution Regime for the Indian Financial System
3.16 Work relating to an effective resolution
mechanism has been initiated under the aegis of the
Sub-Committee of the Financial Stability and
Development Council (FSDC). The working group set
up to suggest steps for strengthening the resolution
regime submitted its report in January 201412.
Considering the special nature of financial institutions,
as well as limitations in applying corporate insolvency
laws to these institutions, the working group has
recommended that there should be a separate
comprehensive legal framework for resolving financial
institutions and financial market infrastructures
(FMIs). The main recommendations of the working
group are in line with FSB’s key attributes and include
inter-alia, establishing a single Financial Resolution
Authority (FRA), developing prompt corrective action
(PCA) by all regulators for the entities under their
regulatory jurisdiction and a financial holding
company structure to improve the resolvability of
financial conglomerates.
3.17 In addition to sufficient going-concern loss
absorbency, one of the important requirements for
enabling an effective resolution is related to the need
for gone-concern loss-absorbing capacity (GLAC) in
the form of a sufficient term debt (for example, bonds)
for losses exceeding the equity base. GLAC is mainly
expected to come from senior unsecured bonds or
subordinate bonds and is conceptually different from
(and in addition to) the notion of ‘contractual bail-in’ debt instruments for recovery or resurrection13. In
view of the need of implementing an effective
resolution regime, the need for newer types of capital,
especially debt and hybrid instruments, is being felt
across jurisdictions. In the Indian context, the share
of borrowings in total liabilities is very low, and
therefore a stronger push is required for encouraging
banks to increase the debt component of their capital
structure through a mix of instruments, without
seriously compromising on the prudential limits for
leverage, including those amenable for ‘bail-ins’.
Shadow Banking
3.18 The FSB policy recommendations for oversight
and regulation of shadow banking relate to five areas viz.,
(i) reducing the susceptibility of money market
funds (MMFs) to ‘runs’; (ii) aligning the incentives
associated with securitisation; (iii) mitigating the spill
over effect between the regular banking system and
shadow banking; (iv) addressing risks associated with
securities financing transactions and (v) assessing and
mitigating systemic risks posed by other shadow
banking entities and activities. As the regulation of
the banking sector is becoming stringent with
increasing capital requirements and legal and
compliance costs, more and more bank-like activities
tend to move into the ‘shadow banking’ sector.
3.19 The motivation for regulatory reforms in the
shadow banking space in developed economies,
especially in the US, emanated from certain dilemmas
that, on the one hand, there was a need to de-risk the
overgrown complex banking industry which inevitably
needs the presence of shadow banking entities to
absorb those risks and the concerns over the role of
shadow banking entities in consummating the
financial crisis, on the other. For developing markets like India these concerns may not be fully valid, given
the low penetration of banking services, much less
complex financial markets and level of regulatory
oversight exercised over shadow banking activities.
3.20 On the other hand, the alliance between
technology and finance is heading towards a new
paradigm with the emergence of peer-to-peer (P2P)
lending/crowd funding technology platforms (Box
3.1). While in certain regulatory jurisdictions this
space is being looked at as more favourable, some
other regulators have raised concerns mainly relating
to distress for lenders in the event of a sudden closure
of such platforms14. While these platforms are still
new to India and the scale of transactions is
insignificant, this is a gap which requires regulatory
attention. This is all the more important since in
developed markets, mainstream financial market
participants and products are making an entry into
this space amidst concerns over regulatory arbitrage.
Recently, the Securities and Exchange Board of India
(SEBI) has proposed a framework to encourage and
streamline crowd funding market in India15. The
proposed framework provides for ‘security based
crowd funding’ in India under three routes viz. equity,
debt and fund. The proposal intends to develop an
additional channel for entrepreneurs to raise early
stage funding and seeks to balance the same with
adequate investor protection measures.
3.21 The trend of large amounts of cash accumulation
(in various liquid forms) by non-financial companies
(NFCs), resulting from various reasons ranging from
an uncertain economic environment to industry
specific business cycles, has been commonly
associated with advanced economies and other fastgrowing
big economies. The previous FSR mentioned a similar phenomenon of changing asset composition
in favour of financial investments of Indian corporate
entities16. Further, the aggregate share of cash and
bank balances in total assets of large NFCs17 has broadly seen an increasing trend since 2004
(Chart 3.2).
Box 3.1: Peer-to-Peer Lending/Crowd Funding
Peer-to-peer lending (P2P lending), also referred to as
‘social investing’, ‘marketplace lending’ or ‘direct
consumer lending’ is the practice of borrowing and
lending of money among unrelated individuals and
business entities on online platforms without any role
for a traditional financial intermediary like a bank or a
non-banking financial institution. Crowd funding is a
common term where small amounts of money from a
large number of individuals/organisations is raised to
fund an art work, social cause or start-up venture through
web-based platforms. P2P lending is carried out through
websites of P2P lending companies, using different
lending ‘platforms’ which charge a relatively small
commission for their services. P2P lending companies,
apart from finding potential lenders and borrowers, also
provide support services like verification of identity and
financial details of the borrowers, credit models for
pricing of loans and customer service to borrowers. P2P
platforms are able to market themselves as modest
community operations with an advantage of reduced
costs for lending and borrowing. Among the different types of crowd funding (donations for a social cause and
for artistic endeavours) and those that promise financial
returns (by lending or equity) are of particular concern.
They have also engaged in a securitisation process by
bundling loans and selling them as asset backed
securities to financial institutions. Thus, these crowd
funding platforms have engaged in the traditional
financial intermediation process by exploiting webbased,
social media connectivity. P2P is catching up with
traditional banking both in Europe and the US. Some
attribute this growth to the frustration that borrowers
face with regard to banks’ lending practices. With the
retail business model seeming to be firmly entrenched,
P2P lenders are now allowing institutional investors,
private equity firms and even traditional banks to lend
through them. Indications are that investors can earn
much better returns by buying the safest loans from
some of the P2P platforms and now there are discussions
about developing secondary markets for such loans and
their securitised products.
3.22 An analysis indicates a trend of an increasing
share of ‘other income’ of NFCs, which is observed
across sectors ranging from information technology
(IT) to heavy machineries. These NFCs aiming to use
the huge cash balances to improve their returns on
assets, engage aggressively in ‘financial’ activities
(commonly referred as ‘treasury operations’), and the
‘interest income’ of some NFCs exceeds the overall
net profit of some banks. The fact that the total
‘financial’ income (with a predominant share of ‘interest income’) of the top 10 NFCs (in terms of
income from financial operations as against their core
activities) in FY201319 has consistently surpassed the
comparable income items of their counterparts (top
10 banks in terms of treasury income)20 in the banking
sector, makes them important players in the ‘financial’
sector too (Chart 3.3). While the NFCs in the Indian
system may not be directly engaged in credit
intermediation at this stage, information regarding
the non-core ‘financial’ activities of large NFCs may
need to be captured as part of macro-prudential
surveillance.
Need for Mapping of Size and Profile of Shadow
Banking
3.23 With the present regulatory focus on deposit
taking non-banking finance companies (NBFCs) and
only large systemically important entities among the
non-deposit taking NBFCs, those NBFCs which are
below the asset size threshold of `500 million are not
covered by regulation or surveillance of the Reserve
Bank. Also the NBFCs whose activities, though in the
nature of financial intermediation, do not fit into the
‘principal business criteria’ for regulation are not
under regulation or oversight of the Reserve Bank.
Given the relatively limited reach of the formal
financial system, such entities may be playing an
important role in supporting the efforts towards
financial inclusion. However, there is a need to assess
the collective size and profile of activities of the large
number of non-bank financial entities functioning in
the organised as well as the unorganised sector
(including unincorporated entities which are outside
the purview of the regulatory perimeter). With the
relatively lower levels of financial awareness, this
segment of scattered entities of different hues,
involved in different kinds of activities which are
directly or indirectly in the nature of financial/ investment activities, may assume systemic
importance because of the perception, albeit
incorrect, that all financial activities are coming under
some regulatory framework. Furthermore, ambiguities
related to legal, regulatory and administrative aspects
of certain activities, for example, prize chits and
money circulation schemes, the unlisted collective
investment scheme and multi-level marketing also
point towards the need for clarity in the regulatory
framework.
3.24 A preliminary study carried out by the Shadow
Banking Implementation Group (SBIG) comprising of
members from all financial sector regulators,
concluded that there was a high degree of heterogeneity
in business models and risk profiles across various
non-bank financial entities in the organised (including
the entities not ‘registered’ with any of the regulators)
as well as the unorganised (‘informal’) sector. The
study stresses on the need for a large scale survey by
the National Sample Survey Organisation (NSSO) or
other such agencies to estimate the size of the
‘informal financial sector’.
3.25 Apart from such NBFCs, SBIG has also
identified ‘exempted’ provident funds, unregulated
chit funds, co-operative and credit societies and
primary agricultural credit societies as groups of
institutions that need a greater degree of oversight.
Also, government owned entities discharging the
functions as special NBFCs which are exempt, by
statute, from adherence to prudential regulations and
given their systemic significance, are an area of
concern. Certain other entities such as special purpose
vehicles (SPVs) are not regulated and can cause overleveraging
and risks to the financial system.
3.26 The Reserve Bank is in the process of
reviewing the extant regulatory framework for NBFCs,
based on the recent developments in the sector and
also the recommendations made by Nachiket Mor
Committee. The proposed review will cover the
legislative framework of the NBFC sector, asset
classification and provisioning norms for NBFCs
vis-a-vis that of banks – (including the need for raising
Tier 1 capital requirement for NBFCs), corporate
governance guidelines including ‘fit and proper’
criteria for their directors, regulation of deposit
acceptance activity, consumer protection measures,
present classification scheme of NBFCs and activity
of lending against shares by NBFCs.
Asset Reconstruction Sector
3.27 In the context of the deterioration in the asset
quality of banks, recent Reserve Bank guidelines21
propose a corrective action plan that offers incentives
for early identification of stressed assets by banks,
timely revamp of accounts considered to be unviable
and prompt steps for recovery or sale of assets in the
case of loans which are likely to turn NPAs. There has
been a spurt in the sale of NPAs by banks to asset
reconstruction companies (ARCs) over the last few
quarters (Chart 3.4).
 3.28 The share of PSBs in the total amount of assets
sold to ARCs reflects the acute stress on PSBs’ asset
quality and the need for prompt action (Chart 3.5). As
the level of sales to ARCs may remain high during the
next few quarters, the role of ARCs assumes greater
importance. In keeping with the renewed focus on
factoring and asset reconstruction as two pillars of
India’s financial infrastructure in the future, a slew
of positive measures have been undertaken to
rejuvenate the sector (Box 3.2).
 3.29 As most of the securitisation activity is taking
place predominantly with the issuance of securities
receipts (SRs) rather than cash, there is concern that
banks may tend to use this option to evergreen their
balance sheets. SRs may not carry the stigma of nonperforming
assets (their value mainly being derived
from the collateral and not based on the record of
recovery), although the risk of loss of income on the
asset still remains, in effect, with the originator, i.e., the bank (Chart 3.6). Under the current framework,
the ‘real’ incremental value addition of ARCs in the
process of ‘reconstruction’ of assets, over banks’
traditional skills and informational advantage
(stemming from their credit appraisal, monitoring
and recovery processes) also needs to be assessed.
Further, as the banking industry has a significant stake
in the ownership of most of the ARCs presently
functioning in India, the spread of risks may not be
taking place effectively.
 Box 3.2: Functioning and Regulation of ARCs and Recent Policy Developments
The SARFAESI Act, 2002 provides for securitisation and
reconstruction of financial assets and enforcement of
security interest and for matters connected therewith or
incidental thereto by securitisation companies/
reconstruction companies (SCs/RCs) registered with RBI.
SCs/RCs registered with the Reserve Bank of India are
subject to entry point, minimum ‘owned funds’ norms
and the ‘fit and proper’ criteria. SCs/RCs can acquire assets
from banks and financial institutions and issue security
receipts (SRs) to qualified institutional buyers (QIBs) and
can resort to the measures for assets reconstruction as
provided in the Act. A key advisory group constituted by
the Government of India to study issues involving the
lack of effectiveness of asset reconstruction companies (ARCs) had recommended certain measures including
reserve price quotes by banks for auctioning their NPAs,
gradual write-off of losses on sale of NPAs to ARCs,
removal of cap by FIIs on investment in SRs, permitting
ARCs to freely sell or lease businesses, acquiring NPAs
underlying the SRs from other ARCs for debt aggregation
and allowing ARCs to go public to raise capital. Several
amendments to the SARFAESI Act, 2002 have been made
as notified in January 2013.
Recent Policy Developments:
1. SCs/RCs are now permitted to acquire debt from other
SCs/RCs subject to certain conditions and to convert a portion of the debt into shares of the borrower
company as a measure of asset reconstruction.
2. ARCs are required to obtain the consent of secured
creditors holding not less than 60 per cent of the
amount outstanding to a borrower as against 75 per
cent earlier.
3. SCs/RCs with acquired assets in excess of `5 billion
can float a fund under a scheme and utilise up to 25
per cent of the funds raised from QIBs for restructuring
of the financial assets acquired.
4. SCs/RCs may participate in public auctions of nonperforming
assets conducted by their sponsor banks.
5. Promoters of the defaulting company/borrowers or
guarantors are allowed to buy back their assets from
SCs/RCs subject to certain conditions that are helpful
in the resolution process and in the minimisation of
costs.
6. Guidelines on a uniform accounting standard for ARCs
have been advised for reckoning acquisition cost,
revenue recognition and valuation of security receipts
(SRs). The accounting guidelines are to be effective
from accounting year 2014-15.
7. With a view to facilitating greater participation of
foreign investors in providing capital to the asset
reconstruction sector, the ceiling on foreign
investment in ARCs has been increased, to 100 per
cent, subject to the condition that no sponsor may
hold more than 50 per cent of the shareholding in
ARCs either by way of foreign direct investment (FDI)
or by way of routing through foreign institutional
investment (FII).
8. The limit of FII investment in SRs issued by ARCs has
been enhanced from 49 percent to 74 percent. Such
investments should be within FII limit on corporate
bonds prescribed from time to time, and sectoral caps
under the extant FDI Regulations.
3.30 Apart from the focus on asset reconstruction,
effectiveness of various measures to improve the asset
quality of banks will also depend on the efficient
functioning of the corporate debt restructuring (CDR)
mechanism and debt recovery tribunals (DRTs). There
is a need to monitor the efficacy of the processes at
‘entry’, ‘restructuring’ and ‘exit’ stages of restructuring
proposals, under a robust framework of accountability
of different agencies and stakeholders involved. The
incremental number of cases and amount of debt
approved to be taken under the CDR mechanism during a quarter has continued to show an increasing
trend since the December 2013 quarter (Chart 3.7).
3.31 Measures to improve factoring and
management of large credit will help mitigate
problems at both ends of the spectrum, i.e., small and
medium enterprises (SMEs) and large corporations.
The Factoring Regulation Act, 2011 is expected to help
SMEs maintain their cash flows by factoring their
receivables though it may need some push from banks
to engage with this sector as large customers obtain
low cost working capital and overdraft facilities that
obviate the need for factoring services. In addition,
the setting up of the Central Repository of Information
on Large Credits (CRILC) for disseminating credit data
and establishing a joint lenders forum for stressed
assets followed up by a corrective action plan will help
in the timely resolution of stressed assets by banks.
Securities Market
Asset Managers as Source of Systemic Risk
3.32 The asset management industry has been
identified as a potential source of systemic risk in
some regulatory jurisdictions. Key factors that make
the industry vulnerable to shocks are: ‘reaching for
yield’ and ‘herd behaviour’, redemption risk in
collective investment vehicles and leverage, which
can amplify asset price movements and increase the
potential for fire sales.
3.33 In the context of Indian securities markets,
the asset managers are mutual funds, portfolio
managers and alternative investment funds. The
assets under management (AUM) to GDP ratio of
portfolio managers was 6.8 per cent in 2013-14 while
that of the mutual fund industry was 7.3 per cent.
This is significantly lower as compared to the global
average at around 38 per cent in FY 201323. The Indian
scenario with respect to the three main vulnerabilities
has been examined by SEBI to investigate systemic
risks, if any, under the prevailing regulatory
framework (Box 3.3).
Box 3.3: Risk Management Framework for Asset Managers in India
Asset management is an ‘agency’ activity wherein asset
managers manage investors’ assets on their behalf. In
return investors pay fees to the asset managers, wherein
the profit and losses accrue to the investors and not to
the asset management company, thus limiting the
systemic risk faced by the asset management industry.
The risk management framework specified by SEBI for
the asset management industry is significantly
conservative and has weathered many instances of market volatility, disruptions and shocks. The size of the segment
is also very small as compared to FIIs. The asset
management industry in its present form does not appear
to be a source of systemic risk although the focus of the
present public policy debate needs to centre around the
implications of asset management activity in amplifying
pro-cyclical swings in the financial system and the wider
economy.
Apart from mutual funds and portfolio managers, the
only other category of asset managers under SEBI’s
jurisdiction is alternative investment funds (AIFs). As the
assets under the aegis of AIFs are miniscule (in absolute
terms and as ratio to GDP) as compared to those of mutual
funds and portfolio management services, they do not
pose a concern at this stage.
In the Indian context, risk management regulations
prescribed for mutual funds and portfolio managers are
intended to ensure that investments conform to the
mandates and that credit quality, asset concentrations
and other issues are appropriately managed. Funds are
required for disclosing information to investors about
the risks, portfolio holdings, concentrations and
investment strategies. SEBI has also specified operational,
prudential and reporting norms for AIFs.
Redemption risk in funds like mutual funds that offer
unlimited redemption rights is taken care of by adopting
a principle of fair valuation (that ensures that the
valuation of securities is reflective of its realisable value),
by charging exit load (that shall limit redemption), by borrowing to a certain extent against a scheme’s asset to
meet redemption requirements and through the liquid
assets held by the scheme. There is no concept of
redemption in portfolio management services, since the
portfolio manager is simply managing a client’s funds/
securities in his/her own account as per a separate
agreement with each client. Mutual funds are subject to
borrowing restrictions and prohibited from lending. MFs
are not allowed to borrow to invest in securities. The
gross exposure of the MF scheme through equity, debt
and the derivative positions and other assets, cannot
exceed the scheme’s net assets. Furthermore, short selling
of securities is not allowed for mutual funds except under
the stringent framework specified by SEBI. Mutual fund
investments in derivatives are also subject to position
limits and linked to their holding of securities and other
instruments. Portfolio managers are not permitted to
borrow or lend and are also not allowed to leverage with
respect to their derivative transactions, that is, the total
exposure of the portfolio client in derivatives should not
exceed his portfolio funds placed with the portfolio
manager.
Reducing Reliance on Credit Rating Agencies
3.34 One of the regulatory reforms undertaken by
FSB is aimed at reducing the reliance on credit rating
agencies (CRAs). FSB had drawn up three principles
and 12 sub-principles to reduce a mechanistic reliance
on CRA ratings in standards, laws and regulations24.
In India, SEBI is coordinating the process of assessing
India’s compliance/position vis-a-vis the FSB
principles. It has been observed that though there
were references to the use of CRA ratings in the
regulations, financial institutions are required to do
their own due diligence prior to investments as
specified in the regulations. There are requirements
of adequate disclosures by issuer companies which
help investors to take well informed investment decisions. The ratings serve as a supplementary input
for risk assessment and hence there is no mechanistic
reliance on ratings by the institutions.
Resilience of Capital Market Infrastructure
3.35 At the instance of SEBI, stress tests were
carried out by the three clearing corporations in the
securities market to test the resilience of the financial
market infrastructure (FMI) vis-a-vis political and
economic uncertainties. Based on the assumption of
worst case scenario (movement of 20 per cent in
indices in both directions) and offset of the stressed
value against the actual margins collected/available
on those dates, the stress tests showed that these
FMIs had sufficient resources to cover the resultant
losses.
3.36 Also, as a proactive measure to meet any
liquidity crisis situation (similar to those experienced
in 2008 and 2013), SEBI has put up a contingency plan
which includes increasing the borrowing limit of
mutual fund schemes and arranging a special refinance window by the Reserve Bank. For foreign
institutional investors (FIIs), an action plan (with the
use of market wide circuit breakers, margin
requirements and adjustment of position limits in
case of derivatives) has been envisaged for dealing
with a crisis situation which may arise from uneven
political and economic conditions, a fall in sovereign
rating or a market crash.
Cash Market Turnover vis-a-vis Derivatives Market
Turnover in Equity
3.37 India’s stock market has witnessed a strong
growth in market capitalisation over the last two
decades. However, in recent years, the growth in
turnover in the cash (spot) market has not kept pace
with that in the derivative market as is evident in a
declining ratio of average daily turnover in the cash
and derivatives markets (Chart 3.8). Since excess or
disproportionately high activity in the derivatives
market may influence the price formation in the cash
market, there is a need to monitor the trends and take
necessary steps to ensure robust liquidity in the cash
segment as well as in the derivatives segment.
Specifically, there is a need to address any anomaly
in relative transaction costs in the two segments,
including a review of the existing provisions of the
securities transaction tax (STT) as applicable for
different segments and instruments.
 3.38 Within the derivatives segment, index based
products, especially index options, account for a
significantly large share of the total volumes in Indian
equity markets. In 2013, at the two major Indian
bourses, options contracts had a share of nearly
82 per cent in the volume of exchange traded
derivatives, compared to around 68 per cent
worldwide (Chart 3.9). As compared to global markets,
Indian markets have seen relatively higher volumes in index options over stock options and index
futures. Although option contracts have an
asymmetrical pay-off, this substitution is not seen
to be a cause for concern by itself. The faster growth
in trading volumes in options may be resulting from
an effectively lower incidence of STT on option
contracts, relative to futures contracts, as it is applied
on the ‘option premium’ and not the ‘strike price’.
Offshore Derivatives in Indian Equity Markets
3.39 Offshore derivatives instruments (ODIs),
including promissory notes (PNs), are issued by
registered FIIs, through which overseas investors get
exposure in Indian equities or equity derivatives,
subject to the condition that such investors are
regulated by an appropriate foreign regulatory
authority under appropriate ‘know your client’ (KYC)
norms. The percentage ratio of outstanding ODIs/PNs
to total assets under custody (AUCs) has shown an
upward movement as compared to the last financial
year (Chart 3.10).
3.40 The build-up of ODI positions and the
concentrations therein (concentration of entities
holding ODIs, concentration of stocks underlying or
geographical concentrations in holding of ODIs) may
be of systemic concern since any major and sudden
unwinding of these positions triggered by a local/
global event may mirror in the offloading by FIIs in
Indian equity markets. It is envisaged that under the
erstwhile FII regime, some entities might have been
investing through ODIs since they could not get
themselves registered as FII/sub-accounts, a
prerequisite for making investments directly under
the FII regime. Under the revised framework notified
by SEBI25, the FII regime will be replaced by the foreign
portfolio investors (FPI) regime and is expected to
encourage overseas investors to enter the Indian
market directly by registering with designated
depository participants rather than investing via
offshore derivative instruments. Under the FPI regime, category I and category II FPIs (except for
unregulated broad based funds) can issue, subscribe
to or otherwise deal in offshore derivative instruments
(ODIs), directly or indirectly subject to certain
conditions relating to regulation by an appropriate
foreign regulatory authority and KYC norms. All
category III FPI and unregulated broad based funds,
classified as category II FPI (by virtue of their
investment manager being appropriately regulated)
are prohibited from issuing, subscribing or otherwise
dealing in ODIs directly or indirectly.
 Commodities Derivatives Market
Corporate Governance and Warehousing Issues in
the Commodity Derivatives Market
3.41 The national spot exchange crisis (covered in
the last FSR) highlighted the need for strengthening
regulation and corporate governance practices in
financial market infrastructure institutions. The
Forward Markets Commission (FMC), the regulator
agency for the commodity derivatives markets in
India, has reviewed corporate governance norms at
the national commodity exchanges and has taken
steps to diversify their ownership structure and
attract more institutional investors.
3.42 Guidelines for the shareholding structure in
commodity exchanges have been revised. At least 51
per cent of the paid up equity share capital of a
recognised commodity exchange shall now be held
by the public; individual shareholdings have been
capped at 5 per cent of the paid up equity share capital
of a recognised commodity exchange except financial
institutions such as a commodity exchange, stock
exchange, depository, a banking company, an
insurance company and a public financial institution
which can hold up to 15 per cent of the paid up equity
share capital. The exchanges and their boards have
been tasked with setting up risk management
committees for identifying, measuring and monitoring
the risk profile of the exchange and have been directed
to lay down policies for disclosures with regard to
expenditure on certain items such as donations and
related party transactions.
3.43 In order to strengthen the monitoring,
supervision and quality of the warehouses which form
a critical component of financial infrastructure in the
commodity derivatives market, FMC has directed the
commodity exchanges to ensure that all the existing
warehouses accredited by them are registered by the
Warehousing Development and Regulatory Authority
(WDRA) and have obtained a certificate of accreditation
from it.
Financial Safety Net – Deposit Insurance
Need for a Target Fund by a Deposit Insurer for
Financial Stability
3.44 In view of the important role of a deposit
insurance agency, setting and maintaining a suitable
target level for the quantum of funding is required to
ensure that there are adequate funds available in
contingencies. The sources of funds are premiums
collected from member institutions and the returns
earned by investing these funds. Internationally,
many deposit insurers follow the practice of setting
and maintaining a target fund wherein a predetermined
or targeted ratio of the ‘amount of ex ante deposit insurance fund’ to ‘insured deposits’ is set
and maintained. The guidelines issued by the
International Association of Deposit Insurers (IADI)
on appropriate methodologies for determining the
optimum quantum of funds include utilising existing
knowledge in evaluating financial reserves sufficiency
on the basis of a risk analysis.
3.45 Many of the deposit insurers maintain this
ratio at up to 2 per cent though some of the countries
go up to 5 per cent. In case of the Deposit Insurance
and Credit Guarantee Corporation (DICGC), the
reserve ratio (deposit insurance fund/insured
deposits) stood at 1.7 per cent at end-March 2013.
While, so far there is no targeted level of the reserve
ratio for DICGC, it would be desirable to set a target
ratio based on a detailed assessment of the risk.
Insurance Sector
Lending Activity of Insurance Companies
3.46 The Insurance Act, 1938, defines the various
ways in which insurance companies can deploy their
funds, which includes various kinds of loans (for
example, loans against policies and loans against
mortgage of property in India and abroad). Related
regulations lay out the exposure/prudential norms in
debts/loans and the provisions for considering some
types of loans to be covered under ‘other investments’.
3.47 The lending activity of insurance companies
- mainly the life insurance companies, while not very
large in comparison to total banking sector lending,
is nevertheless significant. The quantum of lending
by insurance companies which stood at `888.7 billion
as at end-March 2014, constitutes less than 5 per cent
of the assets under management (`20,990 billion as
at end-March 2014) of insurance companies and a
significant portion of these loans is secured against
the surrender values of life insurance policies. While
risk management framework and exposure limits
(single issuer, group, and industry) are in place for
insurance companies, there is a need to plug the
possibility of any regulatory arbitrage by closely aligning the practices and regulations applicable to
lending by insurance companies with those by banks.
A coordinated approach and sharing of information,
being facilitated by FSDC, will enhance the efficiency
of monitoring of exposure details of large borrowers
and functioning of the Joint Lending Forum, under
the Reserve Bank’s framework for revitalising stressed
assets.
Pension Sector
3.48 The importance of pension funds lies not only
in promoting old age security but also in ensuring
financial stability in multiple ways. Although pension
funds are termed ‘passive investors’ (because portfolio
churning is low) due to their ‘buy and hold’ strategy
with a sizeable presence they can ensure market
stability by acting as a countervailing power in the
face of large scale sell-offs. Pension funds being large
shareholders with a long-term investment strategy
tend to play an important role in bringing in the best
practices of corporate governance in companies that
get the investments. Also, permitting pension funds
to invest in equity/debt instruments can play a dual
role in not only providing better returns to their
constituents but, at the same time, also in developing
the capital market. Pension funds can be major
stimulators of financial innovation as suggested by
international experience.
3.49 Given India’s huge population and a pension
coverage of barely 12 per cent, India’s potential
pension ecosystem is enormous and is growing
rapidly. Currently, one end of the spectrum is the
defined benefit (DB) pension schemes of which the
two main schemes are the pre-reform civil services
pension scheme of the central/state governments
(which has been replaced by the National Pension
System for new recruits) and the ‘organised sector’
social security scheme operationalised by the
Employees’ Provident Fund Organisation (EPFO). At
the other end of the spectrum are the defined
contribution (DC) schemes of which the National
Pension System (NPS) introduced from January 2004 is the most important addition to the Indian pension
sector. In the case of several DB schemes both
currently under implementation and newly announced
ones (mostly in the government sector), lack of
liability computation especially in a world of rising
life expectancy can be a potential source of fiscal stress
in years when there are large payouts. Continued
reliance on unsustainable pay-as-you-go pension
schemes in the government has the potential of
having an adverse impact on financial stability by
raising fiscal deficit.
3.50 Keeping subscriber interest as prime, several
initiatives like allowing withdrawals on specific
eventualities to make the NPS more subscriber
friendly, selection of pension fund managers (PFMs)
and price discovery of investment management fees
through competitive bidding and appointing the 2nd
CRA are some of the measures that have been
undertaken recently. Further, as mandated by the
Pension Fund Regulatory and Development Authority
(PFRDA) Act, 2013, developing a minimum guarantee
pension product is also underway. These and other
initiatives are aimed at speeding the coverage of NPS
for achieving the goal of ‘universal old age pension
security in India’. The NPS has seen substantial
growth in terms of number of subscribers and AUM
(Chart 3.11).
 3.51 However, the corpus of assets under NPS’
management does not pose systemic concerns at
present, as it is still in its accumulation stage and
extreme fluctuations are likely to even out over the
long-term duration of the corpus. Given the diversified
nature of the portfolio, the pension fund sector is
unlikely to be impacted severely by volatility in the
financial markets.
Financial Market Infrastructure
Cost-Benefit Analysis of Single CCP vis-a-vis
Multiple CCPs
3.52 The central counterparties (CCPs) as financial
market infrastructure (FMI), have become critical
nodes in the financial system. The failure of a CCP
could contribute to systemic risk which could further
exacerbate on account of interconnectedness.
Therefore, the effectiveness of a CCP’s risk
management and the adequacy of its financial
resources are critical aspects of the infrastructure of
the markets that it serves. Assisted by a regulatory
push, more and more OTC derivative products are
moving to CCP clearing. Although a CCP helps to
reduce risks to market participants significantly, it
also concentrates risks on itself. As CCP clearing has
its own associated costs, individual markets need to
assess the benefits and costs of a CCP clearing based
on the volume and value of transactions, trading
patterns among counterparties and the opportunity
costs associated with settlement liquidity.
Concentration Risks Associated with Single CCP
3.53 The Clearing Corporation of India Limited
(CCIL) operates in the markets regulated by the
Reserve Bank which include the government securities
segment, collateralised borrowing and lending
obligations (CBLOs), and the USD-INR forex and forex
forward segments. In terms of value, CCIL handles
close to around 80 per cent of the total market
volumes of all CCPs put together. Previous issues of
FSR have indicated that CCIL could be a source of
concentration of counterparty risk in the Indian system, given that it is a multi-product CCP, with the
same set of participants operating in different market
segments. The FSRs highlighted the need for adopting
high risk management standards consistent with
international best practices and effective regulatory
oversight for minimising the concentration risk. The
Reserve Bank has been aiming at achieving an optimal
CCP structure to address the concentration risk, while
also ensuring the cost-effectiveness of central clearing.
In this context, the need for a second CCP in markets
regulated by the Reserve Bank has been examined
in detail.
Optimal Composition of a CCP Structure for India
3.54 International experience on optimal structure
and number of CCPs, does not throw up a single clear
solution suitable for all situations as there are many
parameters like the level of funding available to the
CCP(s), the degree of integration between different
groups of participants with specific risk profiles and
the overall financial system. In some of the advanced
jurisdictions, market participants have flexibility to
settle through international CCPs if such products are
available with the international CCPs. Also, with
multiple CCPs operating in some markets,
interoperability and cross margining are resorted to
for enhancing netting benefits. With existing capital
account restrictions and domestic orientation of
clearing and settlement infrastructure, India could
not be strictly compared with such jurisdictions.
However, an analysis of the optimal number of CCPs
for markets regulated by the Reserve Bank was
undertaken based on the international experience
and prevalent market conditions in India (Box 3.4).
Present System of CCPs Seen as Effective in the
Indian Context
3.55 The question of the optimal CCP set-up for a
market like India is complex and will depend on a
trade-off between efficiency in a single CCP structure
and the potential of systemic risk that could arise
from the failure of a single CCP. Another trade-off would be between the maximum netting ratio
achieved by the single CCP solution and the
concentration of risk in a single infrastructure. The
size of the markets is not big enough for an additional
CCP to be self- sustaining. Further, while the costs
and the overall collateral requirement will increase
under the two CCPs model, the benefits expected to
accrue from competition and innovation could be at least partially achieved under the single CCP model
through involvement of user groups in decision
making, improving corporate governance and
introducing regulatory driven products. In view of the
findings of the analysis, it is observed that at present
the single CCP structure in India is offering users the
benefits of economies of scale and efficiency in
collateral and capital usage. The Reserve Bank, however, will need to continuously monitor the
situation according to the evolving needs of financial
markets and avoid the possibility of potential abuse
of the dominant position as well as systemic risks
associated with such a structure.
Box 3.4: Relative Merits of Single CCP and Multiple CCP Structures
Assuming that there is merit in having multiple (at
least two) CCPs, the CCP infrastructure can be possibly
organised under the following two options:
I. Model A: Vertical splitting: Both the CCPs cater to the
same markets
Both the CCPs would operate in both the cash and
derivatives segments and would compete with each
other. Market participants would participate in
either of the CCP based on operational and economic
considerations.
II. Model B: Horizontal splitting: Both the CCPs cater to
different markets
In this arrangement one CCP could cater to the cash
segment viz. government securities including repo, the
money market, CBLO and the forex segment and other
CCP could cater to the derivatives market, both forex
and interest rate (forex forward and IRS). Since they
will cater to different market segments, there will be
no competition and will in all probability have the same
set of participants. The analysis was based on several
parameters – implication on netting of settlement value
and liquidity requirement, impact on counterparty risk
exposures in terms of net mark-to-market (MTM) and
potential future exposures, impact on systematic risk
(operational risk, too-big-to-fail and market failures),
cost effectiveness (both market participants and CCPs)
and competition and innovation.
• From the empirical analysis (on the 31 January 2014
position) undertaken for implications on netting
and implications on current and potential future
exposures it is observed that the two CCPs structure
under Model A reduces the netting benefits
compared to a single CCP model and thereby leads
to increase in liquidity requirements, overall MTM exposures and potential future exposures (PFE) for
the markets. However, a significant impact is not
noticed for the two CCPs structure under Model B
when compared to the single CCP model on account
of cross margining and netting of exposures across
segments not being permitted under the extant
regulatory framework. Further, the analysis does
not take into account the impact of increased
collateral requirements under Model B.
• The two CCPs structure has advantage over the
single CCP structure in minimising systemic risk.
However, it is difficult to empirically derive the cost
of the systemic risk in a single CCP structure. On the
other hand, there are measures to address systemic
risk in a single CCP structure through a combination
of measures such as adopting an effective risk
management, augmenting financial resources to
address defaults, an effective business continuity
plan (BCP)/disaster recovery (DR) arrangements
with high redundancies and high availability and
effective oversight by the regulators.
• From the perspective of CCP participants, a single
CCP structure promotes high network externalities
in terms of economies of scale in transaction costs,
higher ratio of multilateral netting, reduction in
exposure (due to a high netting ratio and a large
number of participants) and reduction in the risk
mutualisation cost (incremental contributions
to the default fund would come down). Network
externalities are generally low in a multi CCPs
structure. Network externalities in multiple
CCPs could be improved through links and
interoperability between the two CCPs, although
they have associated cost and risk implications also
if they are not properly implemented.
3.56 Considering the urgent need for bringing out
legal provisions to provide for netting and settlement
finality in the event of insolvency, liquidation or
resolution of the CCPs itself, certain legal reforms are
being considered by the government. This will help
banks in economising on capital by moving to the CCP
clearings being offered by the CCIL and facilitate
greater participation by banks in forex and interest
rate derivatives markets and also facilitate conformity
by Indian financial markets with globally accepted
principles.
Payment and Settlement Systems
3.57 The payment and settlement systems
continued to perform efficiently as efforts are on to
make them more secure, accessible and inclusive. The
Reserve Bank’s policy in this regard is geared towards
addressing the risks in the system, adhering to
international standards and addressing the issue of
exclusion from access by making payment products
affordable, safe and efficient.
Developments in Pre-Paid Payment Instruments
3.58 In India, banks as well as non-banks are
allowed to issue pre-paid payment instruments (PPIs).
PPIs, as a financial product, are being used to provide
limited banking services such as remittance and
payment services to the unbanked population. The
Reserve Bank, in consultation with all the stakeholders,
carried out a comprehensive review of the guidelines
for issuing and operating PPIs issued in 2009. The revised guidelines were issued in March 2014 with
the major changes relating to enhancing capital and
net-worth requirements for new PPI issuers; need for
clarity related to the credits and debits that can be
made to/from escrow accounts and forfeiting
processes; requirement of immediate credit on
account of failed/returned/rejected transactions and
mandatory and more frequent (at least on quarterly
basis) reporting of incidences of fraud involving PPIs.
 3.59 The annual growth rate in volume and value
of transactions under the PPI channel has decreased
over the last two years especially in value terms
(Chart 3.12). Although the growth rates in volume
appear robust, the segment has shown a lower than
expected level of growth performance. Some of the
plausible reasons behind the limited usage of these
products could be related to lack of ‘acceptance’
infrastructure and restrictions on ‘cash out’. The PPI
segment at present dominated by paper coupons/meal
schemes with limited usage, has the potential to reach
unbanked people who are not able to access formal
banking services.
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