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Report of the Committee on Financial Sector Assessment (CFSA) 2009
REPORT FINDINGS
Financial Institutions
Commercial Banks
Based on the stability assessment and stress testing of the financial institutions, the CFSA has found that commercial banking system in India is broadly sound. While the banks were generally in a position to absorb significant shocks due to credit, liquidity and market risks, there were some concerns relating to liquidity risk due to increasing illiquidity in banks’ balance sheets. There is, therefore, a need to strengthen liquidity management. Looking forward, the stress tests need to be conducted on a more systemic basis, to capture second round and contagion risks. For this purpose, CFSA has recommended setting up of an inter-disciplinary Financial Stability Unit.
The Government ownership of commercial banks poses dilemmas as it has been argued that this could lead to a conflict of roles and regulatory forbearance. The possibility of conflicts of interest could be minimised through even-handed regulation which has been the case in India. Also, the cost of recapitalisation of Indian public sector banks has also been relatively low.
The Government has, in the past, consistently shown willingness to contribute capital and the growth of public sector banks has so far not been constrained because of lack of capital. But, capital augmentation of these banks in future could be a challenge. This could be managed through a variety of ways, such as, amalgamation where commercial synergies exist, raising capital through newer instruments (like issuance of perpetual preference shares in foreign currency). If no other alternative is available, there could be case for selective dilution of government equity which would require amendment of existing legislation.
There is a need for capacity building in the commercial banking sector with accent on training, succession planning, lateral recruitment and improved remuneration (particularly for public sector banks) while at the same time discouraging excessive risk-taking through an appropriate and balanced incentives structure. A well considered approach for entry of foreign banks in India needs to be followed, while adhering to the WTO commitment and norms. Recommending that competition must be encouraged, CFSA has advised encouraging market-based consolidation of banks.
The CFSA notes that the power of the Competition Commission regarding combination could result in delay of amalgamation of banks. Also, certain provisions in the Competition (Amendment) Act 2007 may result in regulatory overlaps and conflicts between the Commission and the statutory regulatory authorities. In the view of CFSA, Central Government could give necessary exemption under Section 54 of the Competition (Amendment) Act 2007 in respect of banks to avoid regulatory conflicts.
The CFSA highlights risk management as a priority area and notes that the counter-cyclical prudential norms imposed by the Reserve Bank have paid dividends in the recent times. It highlights the growing requirement of appropriate accounting and disclosure norms, particularly with regard to derivatives transactions as well as better management of liquidity risk. In this context, the report recommends earmarking a specific capital charge if dependence on purchased liquidity by a commercial bank goes beyond a threshold.
Co-operative Sector
While the financials of urban co-operative banks have improved, these entities still remain vulnerable to credit risk as observed in the stress tests conducted for this sector. The financial indicators of the rural co-operatives throw up some cause for concern. Noting that co-operative and rural banks have dual control, the CFSA has stressed the need for better governance in these institutions.
Non-banking Financial Companies
The CFSA notes that while Non-banking Financial Companies (NBFCs) are important players in financial markets and their financials were broadly satisfactory, funding of this sector is constrained. Development of the corporate bond market would ease funding constraints of this sector. Further strengthening of prudential regulations of NBFCs has also been suggested.
Housing Finance Companies
For the growing and important segment of housing finance companies, the CFSA has noted that having a National Housing Price Index and a Housing Starts Index is a priority.
Insurance Sector
The CFSA noted that the insurance sector has significantly grown in size, penetration and diversified products, has comfortable solvency and capital adequacy. According to the CFSA the following measures need to be taken for further development of the sector:
Supervisory powers of Insurance Regulatory and Development Authority (IRDA) need to be improved;
An effective policy for group-wide supervision needs to be put in place;
Risk management processes require to be improved;
There is a further requirement of skilled professionals – actuaries and treasury managers.
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