5. supervision and supervisory policy board for financial

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Report on Trend and Progress of Banking in India, 2005-06

5. Supervision and Supervisory PolicyBoard for Financial Supervision

2.89 The Board for Financial Supervision (BFS)was constituted on November 16, 1994 by theCentral Board of Directors of the Reserve Bankunder the Reserve Bank (BFS) Regulations, 1994as a Committee of the Central Board to payundivided attention to supervision. The Boardexercises its supervisory role over the financialsystem encompassing banks, both commercialand urban co-operative, financial institutions,NBFCs and primary dealers, over which theReserve Bank has direct supervisory jurisdiction.

2.90 During July 2005 - June 2006, the BFSmet 13 times. Besides delineating the course ofaction to be pursued in respect of institution-specific supervisory concerns, the Board providedguidance on several regulatory and supervisorypolicy matters. The focus of the Board continuedto be on risk management, corporate governance,consolidated supervision and supervision ofconglomerates. The Board also continued tomonitor the progress in respect of internalcontrols, quality of assets in banks andhousekeeping. The findings of on-site inspectionof the Clearing Corporation of India Ltd. (CCIL)and the follow-up actions taken were also reviewedby the Board.

2.91 In the course of its deliberations duringthe year, the Board provided several importantdirections for implementation. Good corporategovernance in the financial institutions wasstressed upon at every stage and it was decidedthat banks having governance concerns becauseof dominant shareholding or other reasons, bekept under close monitoring. It was also suggestedto the Government to extend the ëfit and properstatusí guidelines prescribed for private sectorbanks to the public sector banks as well with aview to attaining higher standards of corporategovernance. Disclosures was another area whichreceived attention of the Board. The Boardísconcern for continuity of a healthy and vibrantfinancial sector and a robust regulatory andsupervisory regime led to the issuance of severalimportant guidelines on credit cards, mergers,disclosures, outsourcing of services and purchase/sale of NPFA by banks.

2.92 The macro approach to financialsupervision has helped the Reserve Bank to refineits regulatory as well as monetary policy stanceso as to achieve the fine balance between growth

and financial stability. At the same time, externalauditors, who are entrusted with the responsibilityof statutory audit of annual accounts of banks,are being increasingly used as an extended armof the supervisory system. They are also requiredto verify and certify certain other aspects such asadherence by banks to statutory liquidityrequirements and prudential norms relating toincome recognition, and classification andprovisioning of assets. In the backdrop of an everincreasing complexity of transactions undertakenby banks, the need was felt for a thorough reviewof the guidelines in respect of a concurrent auditand a system of ëon-lineí audit of businesstransactions of banks. Accordingly, the Boarddecided to constitute a Working Group in April2006 to look into the scope and effectiveness ofthe existing concurrent audit system incommercial banks with a focus on the areas to beincluded/excluded from the purview of concurrentauditors and frame fresh guidelines, includingpreparation of a manual on concurrent audit.

2.93 On-site inspection is an important elementof the supervisory system of banks. With a viewto improving the monitoring of banks andfinancial institutions, the inspection system isregularly reviewed and refined (Box II.15).

Progress in Implementation of Risk BasedSupervision

2.94 Several initiatives have been taken for agradual roll out of the risk based supervision(RBS) process since the announcement made inthe Monetary and Credit Policy of April 2000.Three rounds of pilot run of RBS covering publicsector, private sector and foreign banks wereconducted during 2003-2006. Steps were takento fine-tune the RBS process based on the lessonslearnt from the pilot studies. A guidance note wasprepared to help the inspecting officers during theon-site RBS pilot study. Further, the risk areaswere rationalised to avoid duplication/overlapping. The revised templates provide fornine sections to assess five business risks (credit,market, operational, liquidity and group), twocontrol risks (management and compliance), andcapital and earnings. The operational and grouprisks, which were ënon-keyí risk areas in theearlier model, have now been brought under theambit of ëbusiness risksí, which have been givena significant weightage in the revised RBS system.The new methodology for risk assessment enables

37

Policy Developments in Commercial Banking

Box II.15: Inspection Methodology

The supervision of commercial banks and financialinstitutions is vested in the Reserve Bank in terms of theprovisions of the Banking Regulation Act, 1949 and theReserve Bank of India Act, 1934. This task is carried out bythe Department of Banking Supervision (DBS) under theguidance of the BFS.

The basic objective of supervision of banks is to assess thesolvency, liquidity and operational health of banks. The on-site inspection of banks referred to as Annual FinancialInspection (AFI) is conducted annually (except in the case ofState Bank of India in which case it is done once in twoyears). For this purpose, the unit of inspection is the HeadOffice (HO) of the bank. A team of Inspecting Officers fromthe Reserve Bank led by the Principal Inspecting Officer (PIO)visits the bank and conducts the inspection based on theinternationally adopted CAMEL (Capital Adequacy, AssetQuality, Management, Earnings, Liquidity) model, modifiedas CAMELS (S for Systems and Control) to suit the needs ofthe Indian banking system. The focus of the AFI in recentyears has been on supervisory issues relating tosecuritisation, business continuity plan, disclosurerequirements and compliance with other existing guidelines.

In order to have an overall perspective, units of the bankthroughout the country are also taken up for inspection eitherby the same team inspecting the HO or by additional teamsfrom the Regional Offices (RO) of the Reserve Bank. Theseunits could be treasury operations, specialised branches and

controlling offices in general, where there may be concernsrelating mainly to frauds, NPAs and exposure to sensitivesectors. Major findings of these other unit inspections areincorporated in the Report. The timeframe for carrying outthe inspection of the corporate HO of the bank is two tothree months. The inspection report is generally finalisedwithin four months.

On completion of the inspection, the RO of the Reserve Bank,under whose jurisdiction the HO of the bank is situated,issues the inspection report to the bank for perusal,corrective action and compliance. Further, a detaileddiscussion on the findings of the inspection and the roadahead is conducted by the Reserve Bank with the CEO/CMDand other senior functionaries of the bank and a monitorableaction plan is decided and/or supervisory action is taken,wherever warranted. The findings recorded in the inspectionreport along with the responses of the CEO/CMD of the bankare placed before the BFS. Based on the findings of the inspectionand other inputs, a supervisory rating is assigned to the bank.

Efforts are afoot to move to a risk based supervision (RBS)approach, which envisages the monitoring of banks byallocating supervisory resources and focusing supervisoryattention depending on the risk profile of each institution.The process involves continuous monitoring and evaluationof the appropriateness of the risk management system inthe supervised institution in relation to its business strategyand exposures, with a view to assessing its riskiness.

the supervisors to separately assess the risk forinherent/control risk areas and domestic/overseasoperations in respect of all the business riskareas, thereby providing important inputs forarea-specific supervisory action. The revised risk-rating framework is number driven. It providesgranularity to the supervisory risk-rating process(i.e., assessing the degrees of risk and whetherthe risk is in the upper band or lower band) andenabling preparation of specific supervisoryprogramme/action for individual banks. On-sitepilot study (third in series) was taken up in fourbanks in 2005-06 under the revised RBSframework.

Off-site Monitoring and Surveillance

2.95 The Reserve Bank had instituted a state-of-the-art Off-site Monitoring and Surveillance(OSMOS) system for banks in 1995 as part ofcrisis management framework for Early WarningSystem (EWS) and as a trigger for on-siteinspections of vulnerable institutions. The scopeand coverage of off-site surveillance has since beenwidened to capture various facets of efficiency andrisk management of banks.

2.96 While taking up on-site inspection ofbanks, data from the OSMOS system are used bythe inspecting officers for assessing theperformance of banks. On-line connectivity hasbeen provided to all Regional Offices to enablethem to access the data directly and generatestandard reports. Based on the modification inregulatory norms as also the supervisoryrequirements, the OSMOS system undergoesrevision from time to time. In order to identifyareas requiring urgent supervisory action andinitiate timely action, the time limit for submissionof monthly returns was reduced to 15 days andfor quarterly returns to 21 days across allcategories of banks from June 2005. The ReserveBank remains continuously in touch with thebanks with a view to enhancing data quality.Several measures were initiated during 2005-06to ensure smooth operation of the OSMOS system.These, inter alia, included: (a) modification of theëguidance note on off-site returnsí in the light ofthe latest revision of the system, relevantregulatory changes and common reportingmistakes observed in various returns; and (b)meetings with individual pre-identified banks tohighlight the mistakes committed in the returns,

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removing conceptual ambiguities and sensitisingthem to the importance of off-site returns.

2.97 The efficiency of the reporting mechanismis also being enhanced through more intensiveadoption of technology (Box II.16).

Monitoring of Frauds

2.98 With a view to monitoring closely thefrauds in the financial sector, a separate FraudMonitoring Cell (FrMC) was constituted on June1, 2004 under the overall administrative controlof the Department of Banking Supervision of theReserve Bank. Timely reporting of information onoccurrence of frauds greatly helps the supervisorin disseminating the same to other entities withoutmuch loss of time, which, in turn, helps in curbingfurther perpetration of fraud by the fraudsters.Keeping this in view, a Fraud Reporting andMonitoring System (FRMS) was introduced in2003 to enable banks to report data relating tofrauds in electronic form. The FRMS Package wasrevised in January 2006 to capture granulardetails of frauds under different categories, viz.,housing loans, credit cards, ATM-debit cards andinternet banking, so as to discern the emergingtrends in frauds and enable the entities to focustheir oversight on more vulnerable areas. Numberand amount of frauds reported by banks increasedsignificantly during 2005-06. One of the majorreasons for such a sharp increase in the fraudswas increase in housing loan frauds. Frauds in

the areas of credit/debit cards and ATMs alsoincreased. During 2005-06, commercial banksreported 13,914 cases of frauds involving a sumof Rs.1,381 crore as against 10,450 cases offrauds amounting to Rs.779 crore during 2004-05. These cases were followed up with the banksfor necessary remedial action.

2.99 Frauds were perpetrated in the areas ofcredit, particularly in working capital finance,including bill finance and cheque discounting. Thecommon modus operandi adopted by borrowerswas clandestine removal of hypothecated stocks,drawing of false/benami bills of accommodativenature and submission of fake documents relatingto properties offered as collateral securities.However, during the last two to three years, largescale frauds were reported in the area of housingfinance and multiple creation of equitablemortgages on the same properties offered todifferent banks. Analysis of frauds in the area ofhousing finance revealed the submission of fake/forged title deeds of properties, salary certificates,income tax returns by the borrowers. Laxity inthe conduct of due diligence of borrowers/builders, absence of a system of pre-sanction visitto the project site and laxity in post disbursementsupervision were some other contributory factors.

2.100 As regards multiple creation of equitablemortgages, banks are handicapped to verify theposition of encumbrance as also genuineness ofthe title to the property since at present there is

Box II.16: On-line Returns Filing System (ORFS)

The Reserve Bank receives data from commercial banksand other external agencies through several returns. Whilesome of the returns are statutory, others have beenintroduced to obtain specific information. Originally, mostof the returns were paper based. Of late, the Reserve Bankhas started receiving some of the returns in soft copy form,either through floppies or e -mails. In order to bringuniformity in the mode of receipt of returns from banks,on-line returns filing system (ORFS) is being implementedin two phases.

In the first phase of implementation, likely to be completedby end of 2006, Form A return (statutory) under Section 42(2) of the Reserve Bank of India Act have been brought underthe ORFS, and fifteen other returns have been taken up forinclusion in the system. In the second phase spread over aperiod of two years, all the returns received by the ReserveBank are expected to be brought under the ORFS which willalso involve rationalisation of the returns. The ORFS isexpected to emerge as the single interface for datatransmission between the Reserve Bank and banks.

The on-line returns filing system provides a user-friendlyinterface to banks and straight-through-processingenvironment to the Reserve Bank. The main features of ORFSare: (i) an end-to-end secured data transmission madepossible due to the features of secured web server and MQ-series present in the ORFS; (ii) no need of any additionalhardware or software at the bankís end as banks canuse the system by just logging into the Reserve Banksecured web server (either through INFINET or internet);(iii) automatic authentication of banks as user-id andpassword is required for logging into the Reserve Bankíssecured web server; (iv) facility to enter data on-line andupload data directly from an XML file in the computer systemof the bank; (v) ensured data quality through on-screenvalidation checks; (vi) facility to edit/print/save data beforetransmitting it to the Reserve Bank, so that the banks canpreserve the printouts and soft files for their record andfuture use; (vii) centralised receipt of data ñ the data receivedat the secured web server is forwarded to the respective userdepartments; and (viii) automatic acknowledgement of thereceipt of data to the originating bank.

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Box II.17: IPO Irregularities and the Involvement of Banks

In order to corner retail allotment of shares in the IPO ofvarious companies, over and above the eligible limits fixedby SEBI for retail investors, certain individuals/entitiesmade multiple applications for shares, actively colludingwith depository participants (DPs) and also misusing thebanking facilities. The misuse of the IPO process andmanipulation of the banking facilities for the purpose wasbrought to the notice of the Reserve Bank by SEBI onDecember 16, 2005. The Reserve Bank acted promptly andtook up investigations at the Ahmedabad and Mumbaibranches of banks named in the SEBI order, i.e., BharatOverseas Bank Ltd (BhoB) and Vijaya Bank on December16, 2005. Based on the lead emanat ing from therevelations at these banks, scrutinies were taken up at otherbanks as well.

Based on the findings and taking into account the extent ofacts of omissions and commissions at the banks, penaltiesranging from Rs.5 lakh to Rs.30 lakh have so far beenimposed on 10 banks, viz., BHoB, Indian Overseas Bank,Vijaya Bank, HDFC Bank, ICICI Bank, Standard CharteredBank, Citi Bank, ING Vysya Bank, IDBI Ltd. and CenturianBank of Punjab. The penalties were imposed in accordancewith the powers conferred upon the Reserve Bank videsection 47A (1) (b) of the Banking Regulation Act, 1949,keeping in view the extent and seriousness of irregularitiesobserved in different banks and larger objective ofmaintaining the credibility of the Indian financial sector. Inthe case of a few banks, involvement of the bank officialswas also observed.

The irregularities which came to notice during theinvestigations taken up by the Reserve Bank were notsystemic or widespread in nature. Only 10 banks out of atotal of 89 banks and 22 branches out of a branch networkof over 71,000 were involved in the irregularities. In allsuch cases, banks were asked to initiate criminal action,including filing of cases with police/CBI, against the bankofficials involved.

Immediately on surfacing of the irregularities relating to themisuse of the IPO process, all scheduled commercial bankswere advised to take a review of the financing of IPOs. Allbanks have confirmed having completed the review. Majorityof the banks have reported that no serious irregularities havebeen observed. Corrective action has been initiated in respectof those banks where a few irregularities were observed.

The manipulation of the IPO process was perpetrated dueto weakness in the internal control systems and proceduressuch as failure of the alert systems or weaknesses inreporting lines and the internal inspection and auditprocesses in most of the involved banks, which failed todetect the irregularities. The Reserve Bank initiated detailedinvestigations in these areas and took up the concerns withthe banksí top managements for corrective actions. Otherbanks were also alerted to these deficiencies with advice toplug the loopholes. The importance of the audit andcompliance functions, board oversight, staff training andeducation aspects were reiterated to the banks.

Further, in the misuse of IPO process by certain individuals/entities, it was observed that some banks had credited theproceeds of individual account payee cheques to third partyaccounts instead of accounts of respective payees on therequest of the associates of the DPs. This manipulation wouldnot have taken place without the banks deviating from theprocedure for collection of account payee cheques.Accordingly, a directive was issued prohibiting the banksfrom crediting ëaccount payeeí cheques to account of anyperson other than the payee named thereon.

As non-adherence to ëKYCí guidelines had, by and large,contributed to the occurrence of the irregularities, theguidelines on ëKYCí and ëAMLí standards were revisited andthe date for compliance was extended to March 31, 2006.The banks were also advised on February 15, 2006 to ensurethat a proper policy framework on ëKYCí and ëAMLí measuresis formulated and put in place. All scheduled commercialbanks have reported compliance in this regard.

no institutional mechanism for banks to verify theexistence of charge (equitable mortgage) on aparticular property at a centralised place. Toovercome this problem, the Reserve Bank broughtto the notice of the State Governments and theCentral Government the need for maintaining recordof creation of a charge by a bank/FI on an immovableproperty at a centralised place so as to enable thelending institutions to carry out due diligence beforeaccepting a particular immovable property as asecurity. However, very few State Governments haveinitiated action in this regard so far.

2.101 Irregularities in the case of initial publicofferings (IPO) also surfaced during the year. Theirregularities perpetrated at some of the branchesof a few banks came to the knowledge of theReserve Bank through the findings of the SEBI

inspections. The banking system was misused formanipulation of the IPO process and corneringthe retail portion of the initial public offerings bya few individuals in connivance with thedepository providers. The scam occurred as aresult of total disregard to the laid down ReserveBankís directives, guidelines and instructions onKYC norms/AML standards, opening of accounts,monitoring of large transactions and sanction ofIPO finance or/and loans against shares. TheReserve Bank acted effectively once theirregularities surfaced (Box II.17).

2.102 Disclosure of information in the publicinterest by the employees of an organisation isincreasingly gaining acceptance by public bodiesfor ensuring better governance standards andprobity/transparency in the conduct of affairs of

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public institutions. Large scale corporate frauds theworld over necessitated various legislative measuresfor safeguarding the public interest throughenactments such as Whistleblower Protection Act inthe US, Public Interest Disclosure Act in the UK andsimilar Acts in a few other countries.

2.103 In the Indian context, the Government ofIndia had passed a resolution on April 21, 2004authorising the Central Vigilance Commission(CVC) as the ëdesignated agencyí to receive writtencomplaints or disclosure on any allegation ofcorruption or misuse of office and recommendappropriate action. The jurisdiction of the CVCin this regard is restricted to the employees ofthe Central Government or of any Corporationestablished by it or under any Central Act,Government companies, societies or localauthorities owned or controlled by the CentralGovernment. Thus, the public sector banks andthe Reserve Bank are also under the purview ofthe Government of India resolution.

Credit Information on Borrowers

2.104 As announced in the Annual PolicyStatement for the year 2004-05, the CreditInformation Bureau of India Limited (CIBIL) wasadvised to work out a mechanism, in consultationwith the Reserve Bank, Small IndustriesDevelopment Bank of India (SIDBI) and IndianBanksí Association (IBA), for development of asystem of proper credit records to enable the banksto determine appropriate pricing of loans to smalland medium enterprises. CIBIL is currently in theprocess of exploring solutions in association withits technology partner, Dun & Bradstreet InformationServices India (P) Ltd. (D&B) either by modifyingthe existing system of CIBIL to segregate SMEs dataor creating a separate system for drawinginformation from database of both CIBIL and D&B.CIBIL held discussions in this regard with IBA, SIDBIand the Reserve Bank. The proposed SME solutionwill provide consolidated report comprising SMEloan related data, SME vendor payment related dataand a consolidated SME score. With a view tostrengthening the legal mechanism and facilitatingcredit information bureaus to collect, process andshare credit information on borrowers of banks/FIs, the Credit Information Act was passed in May2005. Subsequently, the Reserve Bank released thedraft rules and regulations under the Act forfeedback on April 5, 2006. On the basis of theresponses received, the draft rules and regulations

have been revised and would be notified shortly inconsultation with the Government of India (seedetails in Section 11).

Compliance Function in Banks

2.105 In April 2005, the Basel Committee onBanking Supervision (BCBS) published a paperentitled ëCompliance and the Compliance Functionin Banksí, prescribing certain principles aimed atstrengthening compliance structure in banks. TheBCBS defined compliance risk as ëthe risk of legalor regulatory sanctions, material financial loss, orloss to reputation a bank may suffer as a result ofits failure to comply with laws, regulations, rules,related self-regulatory organisation standards, andcodes of conduct applicable to its banking activities(together, ëcompliance laws, rules and standardsí)í.Consequently, a Working Group consisting of a fewcompliance officers of banks was set up to reviewthe existing organisational structure and compliancemachinery in banks, weaknesses in the existingsystem, international standards and best practicesand to make recommendations with a view to puttingin place a robust compliance system in banks.

6. Financial Markets

2.106 Well developed financial markets enable thecentral bank to effectively conduct monetary policyand help in improving the allocative efficiency ofresources. Interest rates on benchmarkGovernment securities facilitate appropriate pricingof other financial assets. It has, therefore, been theendeavour of the Reserve Bank to promotedevelopment of all the segments of financial marketunder its regulatory provision. This is sought to beachieved by easing restrictions on transactions,reducing transaction costs, increasing the width anddepth of the market and introducing trading andsettlement systems in line with international bestpractices. During 2005-06, a number of steps weretaken to strengthen the institutional framework forfinancial markets in order to improve the pricediscovery process and, at the same time, ensurethe orderly functioning of various financial marketsegments. The policy initiatives during 2005-06were, in particular, guided by provisions of theFiscal Responsibility and Budget Management(FRBM) Act, which, inter alia, prohibits the ReserveBank from participating in the primary issuancesof Government securities with effect from April 1,2006. This has completed the transition to a fullymarket based issuance of Government securities,

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a process that was initiated in the early 1990s withthe introduction of auctions. The implementationof the FRBM Act also necessitated a review ofReserve Bankís market operations, includingintroduction of new instruments and refiningexisting instruments in the context of the evolvingscenario. Accordingly, a Financial MarketsDepartment (FMD) was set up in July 2005 in theReserve Bank with a view to (i) enhancing efficiencyin operations of the Reserve Bank in the money,the Government securities and the foreign exchangemarkets; and (ii) moving towards functionalseparation of debt management from monetarymanagement. Furthermore, the Committee onFuller Capital Account Convertibility recently madesome recommendations for the sound developmentof financial markets (Box II.18).

Developments in the Money Market

2.107 The money market is the main conduit fortransmitting the monetary policy impulses to the realsector of the economy. The broad policy objectivesthat are being pursued for the development of themoney market are ensuring stability in short-terminterest rates, minimising default risk and achievinga balanced development of various segments of themarket. In pursuance of the recommendations ofthe Internal Technical Group on Money Market (May,2005), the Reserve Bank has been encouraging thegrowth of the collateralised segment, developing therupee yield curve, improving transparency and betterprice discovery and providing avenues for better riskmanagement. The process of transforming the call/notice money market into a pure inter-bank marketwas completed in August 2005. This has beenfacilitated by the development of the CBLO and therepo market outside the Reserve Bank in whichnon-bank participants are allowed to even out theirshort-term mismatches in liquidity. In order toensure the growth of the money market along soundlines, prudential limits have been placed onborrowings and lendings of banks and primarydealers (PDs) in the call/notice money market.

2.108 Following the Annual Policy Statement for2005-06, a screen-based negotiated quote-drivensystem for dealings in the call/notice and the termmoney market (NDS-CALL) developed by theClearing Corporation of India Ltd. (CCIL) waslaunched on September 18, 2006. The introductionof NDS-CALL will help in enhancing transparency,improving price discovery and strengtheningmarket microstructure.

2.109 †A significant development during 2005-06 was the substantial migration of money marketactivity from the uncollateralised call moneysegment to the collateralised market repo andCBLO segments. In order to enable marketparticipants to assess the liquidity conditions inan efficient and transparent manner, informationon transactions in the collateralised segment ofthe money market is also being provided on theReserve Bankís website from April 2006.

2.110 The Reserve Bank has been modulatingliquidity conditions keeping in view the evolvingcircumstances. In order to fine-tune the liquiditymanagement, a Second Liquidity AdjustmentFacility (SLAF) was operationalised with effectfrom November 28, 2005 with features similar tothose of the Liquidity Adjustment Facility. Anadditional LAF was conducted on March 31, 2006in order to facilitate funds management by bankson account of the year-end closing on March 31,2006 coinciding with a reporting Friday.

2.111 The minimum maturity period of CDs wasreduced from 15 days to 7 days with effect fromApril 29, 2005 in order to align it with theminimum maturity of CP and fixed deposits withbanks. With a view to enhancing transparency andfacilitating wider dissemination, information onCP issuance such as issue and maturity date, issueamount, discount/interest rate, unconditional andirrevocable guarantee and credit rating of theguarantor, as reported by the Issuing and PaymentAgents (IPAs) on the NDS platform, has been madeavailable on the website of the Reserve Bank witheffect from July 1, 2005.

Developments in the Government SecuritiesMarket

2.112 As the debt manager to the Government, adeep and liquid market for Government securitiesis important for the Reserve Bank for reducingthe cost of Government debt. In terms of theprovisions of the Fiscal Responsibility and BudgetManagement Act (FRBM), the Reserve Bank isprohibited from subscribing to primaryGovernment paper from April 1, 2006. Keepingthis in view, a number of initiatives were takenduring 2005-06 to further deepen and widen theGovernment securities market. These included:permitting short sale in Government securities;introducing the ëWhen Issuedí (WI) market;proposing active consolidation of Governmentsecurities; providing greater responsibilities for

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PDs to support primary issuance; operationalisingthe NDS-Order Matching system; migrating to astandardised T+1 settlement system; andenabling constituents to sell auctioned stock onthe same day.

2.113 As part of its long-term objective ofdeveloping the Government securities market, theReserve Bank introduced the Negotiated DealingSystem (NDS) in February 2002. However, thetrading facilities on the NDS (both negotiated and

Box II.18: Development of Financial Markets ñ Recommendations of the Committee on FullerCapital Account Convertibility

Countries intending to move towards fuller capital accountconvertibility (FCAC) need to ensure that different marketsegments, besides being well developed in terms of physicalinfrastructure, skill and competency levels are also wellintegrated. If different markets remain segmented, any policyshock to influence market behaviour would not get transmittedto the various segments, thus, leading to inefficiency of policyoutcome. Moreover, segmentation also impedes the developmentof a term structure of interest rates which facilitates the conductof monetary policy. The Committee on FCAC made severalrecommendations to further the development of financialmarkets along sound lines as detailed below;

(a) Money Market

ï Prudential regulations be strengthened to encourage capitalinflows.

ï Necessary coordination be ensured by the lead regulator.

ï More players be allowed to access the repo market.

ï The CBLO and the repo markets be allowed to covercorporate debt instruments.

ï Skills be upgraded to develop the inter-bank term moneymarket.

ï Prudential limits for CP and CD be fixed since any unlimitedopening up could have implications for short-term flows.

ï A dedicated cell within the Reserve Bank be set up for closermonitoring of all derivative products.

ï Banks should frame ëappropriate policyí before marketingcomplex derivatives.

ï The market in interest rate futures be activated and interestrate options be allowed. Initially, options could be introducedas OTC derivatives and subsequently they could be exchangetraded.

ï Provision for netting of derivative transactions be made,before opening up the swap market.

ï Internationally aligned accounting standards for derivativesbe developed.

ï Fixed Income Money Market and Derivatives Association(FIMMDA) be suitably empowered to act as a self-regulatoryorganisation to develop market ethics, trading standardsand also undertake regulation of participants, besidesdisseminating information.

(b) Government Securities Market

ï The share of mark-to-market category be progressivelyincreased.

ï Short-selling across settlement cycles with adequatesafeguards be permitted.

ï Gilt funds be exempted from the dividend distribution taxand income up to a limit from direct investment in giltscould be exempted from tax to stimulate retail investmentsin gilts.

ï STRIPS in Government securities should be expeditiouslyintroduced.

ï Non-resident investors, especially longer term investors,could be permitted entry to expand investor base.

ï Repo facility in government securities be widened by allowingall market players without any restrictions.

ï Rapid debt consolidation process be initiated that is tax-neutral.

ï The limit for FII investment in Government securities couldbe fixed at 6 per cent of total gross issuances by the Centreand States during 2006-07 and gradually raised to 8 percent of gross issuance between 2007-08 and 2008-09, andto 10 per cent between 2009-10 and 2010-11. The limitscould be linked to the gross issuance in the previous year towhich the limit relates. The allocation by SEBI of the limitsbetween 100 per cent debt funds and other FIIs should bediscontinued.

(c) Forex Market

ï The spot and forward markets should be liberalised andextended to all participants, removing the constraint on pastperformance/underlying exposures.

ï Separate forex business from lending transactions andintroduce an electronic trading platform on which forextransactions for small and medium customers could takeplace. For very large trades, the Committee proposed ascreen-based negotiated dealing system.

ï Reserve Bankís intervention in the forex market be throughthe anonymous order matching system.

ï Increase in limits for banks on short-term and long-termborrowing/lending overseas to promote more interest paritywith international markets.

ï FIIs be provided with the facility of cancelling and rebookingforward contracts and other derivatives booked to hedgerupee exposures.

ï Currency futures be introduced, subject to risks beingcontained through proper trading mechanism, structureof contracts and regulatory environment.

ï The existing guaranteed settlement platform of CCIL beextended to the forwards market.

ï Banking sector be allowed to hedge currency swaps by buyingand selling without any monetary limits.

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quote driven) were hardly used, largely because theywere less user-friendly. In order to provide NDSmembers with a more advanced and more efficienttrading platform, the NDS-OM trading module wasintroduced effective August 1, 2005 as recommendedby the Working Group on Screen Based Trading inGovernment Securities (Chairman: Dr. R.H. Patil).

2.114 The settlement cycle for Governmentsecurities was standardised to T+1 effective May 11,2005 with a view to providing the participants withmore processing time at their disposal and therebyenabling better management of both funds and risk.Furthermore, with a view to widening the repomarket in Government securities, listed companiesand non-scheduled urban co-operative banks wereallowed to participate effective May 11, 2005.

2.115 In order to enable the successful biddersto mitigate the price risk, the sale of Governmentsecurities allotted to successful bidders in primaryissues on the day of allotment was permitted, withand between constituent subsidiary general ledger(CSGL) account holders under delivery versuspayment (DvP) III, effective May 11, 2005. Untilthen, the sale contract in respect of securitiesallotted to successful bidders in primary issueson the day of allotment could be entered into onlybetween entities having subsidiary general ledger(SGL) account and settled under the ReserveBankís DvP system.

2.116 The Reserve Bankís non-participation inprimary auctions except under exceptionalcircumstances, effective April 1, 2006, as providedin the FRBM Act, has necessitated alternativeinstitutional arrangements to ensure that debtmanagement objectives are met and theGovernment is able to borrow under all types ofmarket conditions without exacerbating marketvolatility. With the withdrawal of the Reserve Bankfrom the primary market, PDs have begun to playa more active and dynamic role. In order to facilitatesmooth operations by PDs, several measures wereundertaken during the year. First, banks, whichfulfill certain minimum eligibility criteria such asminimum net owned funds, minimum CRAR, netNPA position of less than 3 per cent and profitmaking record for the last three years, were alsopermitted to undertake PD business. Second, PDswere permitted to diversify their activities inaddition to their core business of Governmentsecurities, subject to limits. Third, a revised schemefor underwriting commitment and liquidity supportto PDs was introduced from April 1, 2006.

2.117 With the objective of enabling participantsto manage their interest rate risk more efficientlyand also to impart liquidity to the markets, theInternal Technical Group on Government SecuritiesMarket (ITGGSM) (July, 2005) recommendedpermitting short sales in Government securities ina calibrated manner which would enable marketparticipants to express their views on interest rateexpectations. Accordingly, effective February 28,2006, banks and PDs were allowed to undertakeoutright sale of Central Government datedsecurities that they do not own, subject to the samebeing covered by outright purchase from thesecondary market within the same trading day. Theintra-day short selling has been permitted subjectto certain stipulations in terms of stock-wise limitsand overall risk limits. Keeping in view the feedbackreceived from the market so far, allowing short-salesacross settlement cycles and allowing sale of repoedstock are under active consideration.

2.118 The ITGGSM had also recommended activeconsolidation of securities in order to impartliquidity to the Government securities market,which would involve replacing illiquid securitieswith the liquid securities. Various alternatives ofactive consolidation have been worked out and theconsolidation process would be taken up once themethodology is finalised.

2.119 As part of restructuring the debt issuanceframework in the light of the FRBM Act, WItransactions have been permitted in CentralGovernment securities from May 2006, inpursuance of the recommendations of the ITGSSM.ëWhen Issuedí, a short form of ëwhen, as and ifissuedí, indicates a conditional transaction in asecurity authorised for issuance but not as yetactually issued. All WI transactions are on an ëifíbasis, to be settled if and when the actual securityis issued. ëWIí market facilitates the distributionprocess for Government securities by stretchingthe actual distribution period for each issue byallowing the market more time to absorb largeissues without disruption. Furthermore, it alsoenables price discovery process by reducinguncertainties surrounding auctions. Actual tradingin the WI market commenced with the auction ofCentral Government securities during the weekAugust 1-8, 2006. Subsequently, it took placeduring the auctions of August 14-18, 2006 andSeptember 4-8, 2006. Up to September 30, 2006,total traded volume in the WI segment stood atRs.440 crore.

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Developments in the Foreign Exchange Market

2.120 The Reserve Bank initiated a number ofmeasures during 2005-06 to create a moreconducive environment for external transactionswhile according high priority to customer service.The thrust of reforms in the current accounttransactions was on removing the restrictions andsimplifying the procedures. The approach in thecase of capital account has been gradual withsequenced liberalisation of transactions. Measureswere also initiated to reduce the transaction cost.AML guidelines were also put in place to maintainthe integrity of the market.

2.121 With a view to deepening the foreign exchangemarket and synchronisation of trading across themoney, the Government securities and the foreignexchange markets, the closing time for inter-bankforeign exchange market in India was extended byone hour up to 5.00 p.m. effective May 16, 2005.

2.122 With the progressive liberalisation of foreignexchange related transactions, more entities havebeen allowed to handle non-trade current accounttransactions. In continuation of this process, selectfull-fledged money changers, urban co-operativebanks (UCBs) and regional rural banks (RRBs) werepermitted to release/remit foreign exchange for anumber of non-trade related current accounttransactions such as private visits, business travel,fee for participation in global conferences/training/international events, film shooting, medicaltreatment, emigration and emigration consultancyfees. Consequently, scheduled commercial banksholding full-fledged authorised dealers (AD) licensewere designated as AD Category I and thoseundertaking non-trade current account transactionsas AD Category II.

2.123 AD Category I have been allowed to openforeign currency accounts for the project officesestablished under the general/specific approval ofthe Reserve Bank. They have also been permittedto allow intermittent remittances by project offices,without approval of the Reserve Bank, subject tocertain conditions. Inter-project transfer of funds,however, require prior approval of the concernedregional office of the Reserve Bank. In the case ofdisputes between the project office and the projectsanctioning authority or other Government/non-Government agencies, the balance held in suchaccount is converted into Indian Rupees andcredited to a special account, and dealt with as perthe terms of settlement of the dispute.

2.124 AD banks were permitted to remit expensesof branch/office or representative abroad up to 10per cent for initial and up to five per cent forrecurring expenses of the average annual sales/income or turnover during last two accounting years,subject to the existing terms and conditions.Furthermore, AD banks were allowed to remit foreignexchange for acquiring shares under ESOP schemeswithout any monetary limit, irrespective of themethod of operationalisation of the scheme, subjectto the following three conditions: (i) the companyissuing the shares effectively, directly or indirectly,holds in the Indian company, whose employees/directors are being offered shares, not less than 51per cent of its equity. (ii) the shares under the ESOPscheme are offered by the issuing company globallyon a uniform basis. (iii) an annual return issubmitted by the Indian company to the ReserveBank through the AD banks giving details ofremittances/beneficiaries. Further, generalpermission has been granted to foreign companiesto repurchase the shares issued to residents in Indiaunder any ESOP scheme, subject to certainconditions.

2.125 With a view to further liberalising the facilitiesavailable to exporters/importers and simplifying theprocedures, several measures were undertakenduring the year. First, ADs were permitted to grantextension of time to realise export proceeds up toUS $ 1 million beyond the prescribed period of sixmonths. Second, the process to open Standby Lettersof Credit for import of gold on a loan basis wassimplified and the period for fixing the price andrepayment of gold loan was rationalised. Third, ADswere allowed to permit airline companies to remitup to US $ 1 million per aircraft towards securitydeposits for payment of lease rentals for import ofan aircraft/aircraft engine/helicopter on operatinglease, subject to certain specific conditions. Fourth,ADs no longer need to follow up submission ofevidence of import involving an amount of US $1,00,000 or less, provided they are satisfied aboutthe genuineness of the transaction and the bona fidesof the remitter. Fifth, residents in India were allowedcancellation and rebooking of all eligible forwardcontracts and banks were allowed to approveproposals for commodity hedging in exchanges ormarkets outside India, subject to certain conditionsand reporting requirements. Sixth, powers weregranted to AD banks to grant GR approval in caseswhere goods are being exported for re-import afterrepairs/maintenance/testing/calibration, subject tothe condition that the exporter shall produce the

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relative ëbill of entryí within one month of re-importof the item exported from India.

2.126 Persons/entities eligible under the FDIroute, other than FIIs, have been permitted to investin the equity capital of asset reconstructioncompanies (ARCs) registered with the ReserveBank. FIIs registered with Securities and ExchangeBoard of India (SEBI) are now allowed to invest insecurity receipts (SRs) issued by assetreconstruction companies (ARCs) registered withthe Reserve Bank up to 49 per cent of each trancheof scheme of SRs, subject to the condition thatinvestment of a single FII in each tranche shouldnot exceed 10 per cent of the issue.

2.127 In order to augment their capital, banks inIndia were permitted to issue perpetual debtinstruments eligible for inclusion as Tier I capitaland debt capital instruments as Upper Tier II capital.FIIs registered with SEBI and Non-Resident Indians(NRIs) have now been permitted to subscribe to theseinstruments, subject to the following conditions: a)investment in perpetual debt instruments should notexceed an aggregate ceiling of 49 per cent of issuesize by all FIIs and 10 per cent by an individual FII;b) the investment should not exceed an aggregateceiling of 24 per cent of each issue by all NRIs andfive per cent of each issue by a single NRI; c)investment by FIIs in debt capital instruments (TierII) shall be within the limits stipulated by SEBI forFII investment in corporate debt; and d) investmentby NRIs in debt capital instruments (Tier II) shall bein accordance with the extant policy for investmentby NRIs in other debt instruments.

2.128 In view of the increased concerns regardingmoney laundering activities and to preventauthorised money changers (AMCs) from beingmisused for such activities, the Reserve Bank issueddetailed AML guidelines to enable AMCs to put inplace the policy framework and systems forprevention of money laundering while undertakingmoney exchange transactions. In terms of theguidelines issued, all AMCs are required toformulate suitable policies and procedures for theAML measures which include: (i) customeridentification procedure ñ ëknow your customerínorms; (ii) recognition, handling and disclosure ofsuspicious transactions; (iii) appointment of MoneyLaundering Reporting Officer (MLRO); (iv) stafftraining; (v) maintenance of records; and (vi) auditof transactions in accordance with the guidelinesissued. The AML policy framework and measureswere to be formulated and put in place before March

31, 2006 with the approval of the boards ofdirectors of AMCs.

2.129 The AML guidelines were further modifiedin view of the difficulties expressed by AMCs inimplementing some of the guidelines. Theseincluded: (i) photocopies of the identificationdocument need not be kept on record for purchaseof foreign exchange of less than US $ 200 or itsequivalent; (ii) the photocopies of the identificationdocument should be maintained for one year andcompletion of statutory audit for encashment offoreign exchange between US $ 200 and US $ 2000or its equivalent; (iii) the photocopies of theidentification document should be maintained for aminimum period of five years for encashment inexcess of US $ 2000 or its equivalent; and (iv)requests for payment in cash by foreign visitors/Non-Resident Indians may be acceded to the extent ofUS $ 2000 or its equivalent.

2.130 The policy on external commercialborrowings (ECBs) was reviewed and furtherliberalised in August 2005 to include non-Government organisations engaged in micro-finance and NBFCs engaged in manufacturingactivities. The policy for multi-state co-operativesocieties was liberalised in January 2006. Theprepayment limit of ECB was enhanced to US $ 200million from US $ 100 million in August, 2005.

2.131 Overseas investments by mutual fundsregistered with SEBI were liberalised by enhancingthe existing aggregate ceiling from US $1 billion toUS $ 2 billion in July 2006. Further, a limitednumber of qualified mutual funds were permittedin July 2006 to invest cumulatively upto US $ 1billion in overseas exchange traded funds as may bepermitted by SEBI.

2.132 Foreign Institutional Investors were allowedin July 2006 to offer sovereign securities with AAArating as collateral to the recognised stock exchangesin India for their transactions in derivatives segment.

7. Customer Service in Banks

2.133 The Reserve Bank has been undertakingmeasures, on an ongoing basis, for protectingcustomersí rights, enhancing the quality ofcustomer service and strengthening grievanceredressal mechanism in banks. In order to bringall the activities relating to customer service inbanks under a single umbrella, the Reserve Bankconstituted a separate Customer ServiceDepartment (CSD) in July 2006. The functions of

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the Customer Service Department include, inter-alia, disseminating instructions/informationrelating to customer service and grievanceredressal by banks; administering the BankingOmbudsman (BO) Scheme; acting as a nodaldepartment for the Banking Codes and StandardsBoard of India (BCSBI), ensuring redressal ofcomplaints received directly by the Reserve Bankon customer service in banks; and liaisingbetween banks, IBA, BCSBI, BO offices and theregulatory departments with in the Reserve Bank,on matters relating to customer service andgrievance redressal.

2.134 A significant initiative to improve customerservice in recent years has been the setting up ofan independent body called the Banking Codesand Standards Board of India (BCSBI) onFebruary 18, 2006. A ëCode of BankísCommitment to Customersí has been evolvedthrough collaborative effort among the BCSBI, theReserve Bank and the banking industry. Throughthe Code, banks have committed to have in placea ëtariff scheduleí covering all charges. TheBCSBIís role is to evaluate, oversee and enforceobservance of the Code by banks through the

means of ëcovenantí between each member bankand the BCSBI. The BCSBIís objective is to locateand rectify systemic deficiencies by takingcollaborative remedial action rather than throughpenal measures (Box II.19).

2.135 The complaints against banks are handledat two levels in the Reserve Bank. Fifteen BankingOmbudsman Offices handle the complaintsmaintainable in terms of the provisions of theBanking Ombudsman Scheme. Regulatorydepartments in the Reserve Bank handlecomplaints that are not maintainable under theprovisions of the Banking Ombudsman Scheme.The complaints have been categorised into depositaccounts, loans and advances, credit cards,activities of direct selling agents, harassment inrecovery of loans and general/others.

2.136 The Banking Ombudsman Scheme was firstnotified by the Reserve Bank on June 14, 1995under Section 35A of the Banking Regulation Act,1949 to provide for a system of redressal ofgrievances against banks. The scheme sought toestablish a system of expeditious and inexpensiveresolution of customer complaints. The scheme was

Box II.19: Banking Codes and Standards Board of India

The Reserve Bank of India together with 11 other banks inIndia set up the Banking Codes and Standards Board of India(BCSBI) in February 2006 to monitor and ensure thatbanking codes and standards voluntarily adopted by banksare adhered to, in letter and spirit, while providing servicesto individual customers. These industry wide norms havebeen codified in the form of a Code of Bankís Commitmentto Customers (Code), which has been evolved in consultationwith the banking industry and released by the Reserve Bankon July 1, 2006.

The Code is a landmark in the development of banking inIndia as, for the first time, the individual customer has beenprovided with a Charter of Rights which he can enforceagainst his bank. The Code sets out minimum standards ofbanking practices for banks to follow and emphasisestransparency in banksí dealings with its customers. Toachieve the avowed transparency, it provides fordocumentation of banksí fees and service charges in the formof a Tariff Schedule and requires banks to set out a chequecollection policy, compensation policy and a securityrepossession policy. The Code lays great emphasis onproviding full information to the customer before a productor service is sold to him. For post sale conduct, the Codeinsists on banks giving one monthís notice to customer beforemaking any change in their tariff schedule or any change interms and conditions, governing the product, which mayadversely affect the customer.

The cardinal principle that runs across all the provisions ofCode is that banks should not rely on implicit consent from

customers and all product and services should be sold tothe customer only after obtaining his explicit consent inwriting. As a logical corollary of this principle, the Codeprohibits banks from providing unsolicited credit in anyform, including credit cards. The Code addresses the issueof Right to Privacy of customers and also provides forautomatic compensation to be paid, in accordance with thebankís compensation policy, for any financial loss incurredby an individual customer due to undue delays, failure inexecuting mandates or erroneous debits.

The provisions of the Code are applicable to third partyproducts sold through bank branches and the banks areunder obligation to ensure that their direct sales agents alsocomply with the provisions of the Code. BCSBIís purview isrestricted to scheduled commercial banks and 69 banks haveintimated their willingness to become members. BCSBI isin the process of entering into a covenant with 55 of thesemajor banks.

BCSBI combines the best of statutory regulation and self-regulation. It is a collaborative effort between banks andthe Reserve Bank not only in its origin but also in purpose.While banks becoming member of the BCSBI agree toobserve the Code, the Reserve Bank derives supervisorycomfort from banks being members of the BCSBI as it wouldlook into systemic issues that impinge on customer serviceand financial inclusion. The spirit of collaboration is furtherreinforced by the general consultative approach adoptedby the BCSBI in formulating the Code and in i tsimplementation.

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revised twice, first in 2002 and then in 2006. Atpresent, the scheme is being executed by BOappointed by the Reserve Bank at 15 centrescovering the entire country. The BO scheme coversall commercial banks and scheduled primary co-operative banks.

2.137 The revised scheme came into effect fromJanuary 1, 2006. It incorporated new grounds ofcomplaints such as credit card issues, failure inproviding the promised facilities, non-adherenceto the Fair Practices Code and levying of excessivecharges without prior notice. It relaxed themandatory requirement of filing of complaint tofacilitate registering of complaints on-line orthrough e-mail. Further, the complainants can alsoappeal against the award of BO. The schemeprovided for appointment of only serving seniorofficers of the Reserve Bank as BO and thesecretariat of BO would consist of only ReserveBank officers. However, banks are required toappoint nodal officers in their Zonal Offices/Regional Offices for the Scheme. Also, the cost ofthe scheme is borne entirely by the Reserve Bank.Furthermore, in order to enable the BO toconcentrate on the complaints, rather than onarbitration of inter-bank disputes, the arbitrationoption rested with the BO was removed. Therevised scheme has witnessed an unprecedentedsurge in the inflow of complaints mainly due tothe inclusion of credit card related issues within

the ambit of the scheme, the wide publicity givenand the facility of on-line complaint filing.

2.138 In July 2006, banks were advised to placeservice charges and fees on the homepage of theirwebsites at a prominent place to facilitate easyaccess to the bank customers (Box II.20). Acomplaint form, along with the name of the nodalofficer for complaint redressal, could also beprovided on the homepage itself to facilitatecomplaint submission by the customers. Thecomplaint form is required to indicate that thefirst point for redressal of complaints is the bankitself and that complainants may approach theBO only if the complaint is not resolved at thebank level within a month.

Credit Card Operations

2.139 Credit cards have made the concept ofëevery-where and any-timeí banking a reality. TheReserve Bank, over the past few years, has takena number of measures aimed at encouraging thegrowth of credit card operations in a safe, secureand efficient manner. It has also been theendeavour of the Reserve Bank to ensure that therules, regulations, standards and practices of thecard issuing banks are in alignment with the bestinternational practices. As announced in theAnnual Policy Statement for 2004-05, the ReserveBank constituted a Working Group on Regulatory

Box II.20: Service Charges by BanksPrior to September 1999, the IBA used to work out a scheduleof benchmark service charges for the services rendered bymember banks. These were not mandatory in nature, butwere being adopted by all banks. The practice of fixing ratesfor services of banks was consistent with a regime ofadministered interest rates but not consistent with theprinciple of competition. Hence, the IBA was directed by theReserve Bank in September 1999 to desist from workingout a schedule of benchmark service charges for the servicesrendered by member banks. It was decided that individualbanks may be permitted to fix services charges for varioustypes of services rendered by them, with the approval of theirown boards of directors. However, banks were advisedsimultaneously that while fixing the service charges forvarious types of services provided by them, they shouldensure that the charges are reasonable and not out of linewith the average cost of providing these services.

The Reserve Bank continues to receive representations fromthe public about the unreasonable and non-transparentservice charges being levied by banks suggesting that theexisting institutional mechanism in this regard is notadequate. In order to ensure transparency in bankingservices, the above guidelines were reviewed. Accordingly,

banks were advised in May 2006 to display and update, ontheir websites, the details of various service charges in theformat prescribed by the Reserve Bank. The formats couldbe modified depending on products offered but all servicecharges as indicated in the format should be covered. Bankswere also required to display the charges relating to certainessential services to their offices/branches. This may alsobe displayed in the local language. Further, banks were alsorequired to furnish to the Reserve Bank by May 31, 2006,the details of service charges applicable to enable placing ofthem on the Reserve Bankís website.

Banking Codes and Standards Board of India (BCSBI) hasbeen set up as an independent watchdog to ensure that banksdeliver services in accordance with the codes and standardsto which they have agreed. In pursuance of the announcementmade in the Annual Policy Statement for the year 2006-07,a Working Group was constituted on May 18, 2006(Chairman: Shri N. Sadasivan). The Group has beenentrusted to formulate a scheme for ensuring reasonablenessof bank charges and to incorporate the same in the FairPractices Code, the compliance of which would be monitoredby the BCSBI. The Group has since submitted its Report.The recommendations of the Group are being examined.

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Box II.21: Credit Card Operations of Banks

Based on the recommendations of the Working Group onRegulatory Mechanism for Cards, a master circular/guidelines on credit card operations were issued to banks/NBFCs on November 21, 2005. The salient features of theguidelines are set out below:

ï Each bank/NBFC must have a well documented policyfor credit card operations incorporating the Fair PracticesCode for credit card released by the IBA in March 2005.

ï Banks/NBFCs should independently assess the credit riskwhile issuing cards to persons, especially to studentsand others with no independent financial means, andassess the credit limit for a credit card customer on thebasis of self-declaration/credit information.

ï The card issuing banks/NBFCs would be solelyresponsible for fulfillment of all KYC requirements.

ï While issuing cards, the terms and conditions for issueand usage of a credit card should be mentioned in clearand simple language.

ï Card issuers should ensure that there is no delay indispatching bills and the customer has sufficient numberof days (at least one fortnight) for making payment beforethe interest starts getting charged.

ï Card issuers should quote annualised percentage rates(APR) on card products (separately for retail purchaseand for cash advance, if different) giving the method ofcalculation of APR with a couple of examples for bettercomprehension.

ï The bank/NBFC should not levy any charge that was notexplicitly indicated to the credit card holder at the time ofissue of the card and getting his/her consent except forcharges such as service taxes, which may subsequently belevied by the Government or any other statutory authority.

ï The terms and conditions for payment of credit card dues,including the minimum payment due, should be stipulatedso as to ensure that there is no negative amortisation.

ï Changes in charges (other than interest) may be made onlywith prospective effect giving notice of at least one month.

ï In case, a customer protests any bill, the bank/NBFC shouldprovide explanation and, if necessary, documentary evidenceto the customer within a maximum period of sixty days witha spirit to amicably redress the grievances.

ï To obviate frequent complaints of delayed billing, thecredit card issuing bank/NBFC may consider providingbills and statements of accounts on-line with suitablesecurity built therefore.

ï Banks/NBFCs have to be extremely careful about theappointment of service providers while outsourcing,ensuring that they do not compromise on quality ofcustomer service and the bank/NBFCís ability to managecredit, liquidity and operational risks, and the Code ofConduct for direct sales agents (DSAs) as formulated bythe IBA. Banks/NBFCs should have a system of randomchecks and mystery shopping to ensure that their agentshave been properly briefed and trained.

ï Card issuing bank/NBFC would be responsible for allacts of omission or commission of their agents (DSAs/direct marketing agents (DMAs) and recovery agents) withrespect to customerís rights, including personal privacy,clarity relating to rights and obligations, preservation ofcustomer records, maintaining confidentiality ofcustomer information and fair practices in debtcollection.

ï In case, an unsolicited card is issued and activatedwithout the consent of the recipient and the latter is billedfor the same, the card issuing bank/NBFC shall not onlyreverse the charges forthwith, but shall also pay a penaltywithout demur to the recipient amounting to twice thevalue of the charges reversed.

ï Card issuing bank/NBFC should maintain a ëDo Not CallRegisterí (DNCR) containing the phone numbers (bothcell phones and land phones) of customers as well asnon-customers (non-constituents) who have informed thebank/NBFC.

ï Card issuing bank/NBFC should not reveal anyinformation relating to customers obtained at the timeof opening the account or issuing the credit card to anyother person or organisation without obtaining theirspecific consent.

ï Before reporting default status of a credit card holder toCIBIL or any other credit information companyauthorised by the Reserve Bank, banks/NBFCs mayensure that they adhere to a procedure, duly approvedby their boards, including issuing of sufficient notice tosuch card holder about the intention to report him/heras defaulter to the Credit Information Company.

ï In the matter of recovery of dues, banks/NBFCs mayensure that they, as also their agents, adhere to the extantinstructions on Fair Practice Code for lenders as advisedby the Reserve Bank as also the IBAís Code for collectionof dues and repossession of security.

ï Banks/NBFCs/their agents should not resort to intimidationor harassment of any kind, either verbal or physical, againstany person in their debt collection efforts.

ï Card issuing bank/NBFC should constitute a grievanceredressal machinery within the bank/NBFC and give widepublicity about it through electronic and print media.

ï If a complainant does not get satisfactory response fromthe bank/NBFC within a maximum period of thirty daysfrom the date of his lodging the complaint, he will havethe option to approach the office of the concerned BOfor redressal of his grievance/s.

ï The Standing Committee on Customer Service in eachbank/NBFC may review, on a monthly basis, the creditcard operations, including reports of defaulters to theCIBIL and credit card related complaints. It may takemeasures to improve the services and ensure the orderlygrowth of the credit card operations.

Mechanism for Cards (Chairman: Shri R. Gandhi)on October 26, 2004. Based on therecommendations of the Working Group and

feedback received from card issuing banks and thepublic, guidelines on credit card operations ofbanks were issued in November 2005 (Box II.21).

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Box II.22: Branch Authorisation PolicyFor opening of branches, banks are required to approachthe Reserve Bank with the proposal. While submitting theproposal, banks are advised to follow certain procedures tocomply with the requirements of Section 23 of the BankingRegulation Act, 1949. All specific proposals relating toopening, closing and shifting of all categories of branches,including off-site ATMs, are required to be included in theirannual plan submitted to the Reserve Bank. No separatepermission is required for an on-site ATM that is openedwithin a branch. After a branch has been opened, banksneed to report immediately the complete address and thedate of opening of the branch to the Regional Office concernedof the Reserve Bank. The authorisation granted is valid forone year from the date of issue of the consolidated letter ofauthorisation/permission issued to banks. In case a bank isnot able to open a particular branch due to any genuinereason, it can approach the Regional Office of the ReserveBank for extension of time not exceeding three months.

The branch authorisation policy framework takes intoaccount several elements before granting approval to theopening of new branches by banks. First, while consideringapplications for opening of branches, weightage is given tothe nature and scope of banking facilities provided by banksto common persons, particularly in underbanked areas,actual credit flow to the priority sector, pricing of productsand overall efforts for promoting financial inclusion,including introduction of appropriate new products and theenhanced use of technology for delivery of banking services.Second, such an assessment includes policy on minimumbalance requirements and whether depositors have accessto minimum banking or ìno frillsî banking services,commitment to the basic banking activity and quality ofcustomer service as evidenced, inter alia, by the numberof complaints received and the redressal mechanism inplace in the bank for the purpose. Third, the need to induceenhanced competition in the banking sector at variouslocations is also taken into account. Regulatory comfort isalso relevant in this context. This encompasses: (i) compliancewith principles of regulation; (ii) the activities of the banking

group and the nature of relationship of the bank with itssubsidiaries, affiliates and associates; and (iii) quality ofcorporate governance, proper risk management systemsand internal control mechanisms.

The existing system of granting authorisation for openingindividual branches from time to time has been replacedby a system of giving aggregated approvals, on an annualbasis, through a consultative and interactive process.Banksí branch expansion strategies and plans over themedium-term are discussed by the Reserve Bank withindividual banks. The medium-term framework and thespecific proposals to the extent possible cover the opening/closing/shifting of all categories of branches/offices,including the ATMs. The revised branch authorisation policyhas granted reasonable flexibility and freedom to banks inmatters relating to shifting, conversion of branches andupgradation of extension counters.

The branch authorisation policy for Indian banks is alsoapplicable to foreign banks, subject to the followingconditions. First, foreign banks are required to bring anassigned capital of US$ 25 million upfront at the time ofopening the first branch in India. Second, existing foreignbanks having only one branch have to comply with the aboverequirement before their request for opening of secondbranch is considered. Third, foreign banks are required tosubmit their branch expansion plan on an annual basis. Inaddition to the parameters laid down for Indian banks, thefollowing additional parameters are considered for foreignbanks: (i) track record of compliance and functioning in theglobal markets of the foreign bank and its group (reportsfrom home country supervisors are sought, wherevernecessary); (ii) even distribution of home countries of foreignbanks having presence in India; (iii) treatment extended toIndian banks in the home country of the applicant foreignbank; (iv) bilateral and diplomatic relations between Indiaand the home country; and (v) Indiaís commitments at WTO.ATMs are not included in the number of branches for suchcomputation.

Branch Authorisation Policy

2.140 In terms of the existing provisions, banksare not allowed, without the prior approval of theReserve Bank, to open a new place of business inIndia or change the location of the place ofbusiness, other than within the same city, townor village. While the current policy forauthorisation of overseas branches of Indianbanks would continue, the branch authorisationpolicy was liberalised and rationalised inSeptember 2005 in order to give reasonablefreedom to banks and rationalise the policy foropening of new branches in India. Acomprehensive framework for branchauthorisation policy consistent with the medium-term corporate strategy of banks and public

interest was put in place effective September 8,2005 (Box III.22).

8. Financial Inclusion

2.141 The Mid-term Review of Annual PolicyStatement for the year 2005-06 while recognisingthe concerns with regard to the banking practicesthat tend to exclude rather than attract vastsections of population, urged banks to review theirexisting practices with a view to aligning them withthe objective of financial inclusion. In many banks,the requirement of a minimum balance andcharges levied, although accompanied by anumber of free facilities, deter a sizeable sectionof population from opening/maintaining bankaccounts.

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2.142 With a view to achieving the objective ofgreater financial inclusion, all banks were advisedin November 2005 to make available a basicbanking ëno-frillsí account either with ënilí or verylow minimum balances as well as charges thatwould make such accounts accessible to vastsections of population. The nature and numberof transactions in such accounts could berestricted, but made known to the customer inadvance in a transparent manner. All banks werealso advised to give wide publicity to the facilityof such a ëno-frillsí account, including on theirwebsites, indicating the facilities and charges ina transparent manner. All public and privatesector banks have advised the Reserve Bank ofhaving introduced the basic banking ëno-frillsíaccount. Further, except for those foreign banksthat do not have significant retail presence, allother foreign banks have advised the ReserveBank of having introduced the facility of ëno-frillsíaccount. With a view to encourage financialinclusion, the Mid-term Review of the AnnualPolicy for 2006-07 proposed to simplify the KYCprocedure for opening small accounts. It wasindicated that for such accounts, banks need toseek only a photograph of the account holder andself-certification of address. Outstanding balancesin these accounts at any time would be limited toRs.50,000 and the total transactions limited toRs.2,00,000 in one year. As and when the balancesor total transactions exceed these limits, bankswould be required to convert them into normalaccounts and follow the normal procedure of KYC.It was also indicated that the Reserve Bank wouldissue certain clarifications in respect of conductof the KYC procedure for normal accounts so asto make it more customer-friendly.

2.143 With the objective of ensuring greaterfinancial inclusion and increasing the outreachof the banking sector, it was decided in January2006, to allow banks to use the services of NGOs/SHGs, MFIs and CSOs as intermediaries inproviding financial and banking services throughthe use of business facilitator and businesscorrespondent models. The guidelines issued inJanuary 2006 mainly related to: i) eligible entitiesand scope of activities under business facilitatorand correspondent models; ii) payment ofcommission/fees and other terms and conditionsfor these entities; iii) redressal of grievances; andiv) compliance with the ëKYCí norms.

2.144 Banks were advised that under thebusiness facilitator model, they could use

intermediaries such as NGOs, farmersí clubs, co-operatives, community based organisations, ITenabled rural outlets of corporate entities, postoffices, insurance agents, well functioningpanchayats, village knowledge centers, agri-clinics/agri-business centres, krishi vigyankendras and Khadi and Village IndustriesCommission (KVIC)/Khadi and Village IndustriesCommission Board (KVIB) units, for providingfinancial services, depending on the comfort levelof the bank. Banks were also advised that underthe business correspondent model, NGOs/MFIsset up under the Societies/Trusts Acts; societiesregistered under the Mutually Aided Co-operativeSocieties Acts or the Co-operative Societies Actsof States; companies mentioned under Section 25of the Companies Act, 1956; registered NBFCs notaccepting public deposits and post offices may actas ëbusiness correspondentsí. Banks were advisedsubsequently that the selection/use of NBFCs asbusiness correspondents may be deferred.

2.145 The Reserve Bank advised banks that theymay pay reasonable commission/fee to thebusiness facilitators/correspondents, the rate andquantum of which may be reviewed periodically.As the engagement of intermediaries as businessfacilitators/correspondents involves significantreputational, legal and operational risks, banks wereadvised that due consideration should be given bythem to such risks. Banks were also advised thatthey should endeavour to adopt technology-basedsolutions for managing the risks, besides increasingthe outreach in a cost effective manner.

2.146 Banks were advised to constitute grievanceredressal machinery within the bank forredressing complaints about services rendered bybusiness facilitators and correspondents and givewide publicity about it through electronic andprint media. The name and contact number ofthe designated grievance redressal officer of thebank were required to be made known and widelypublicised. Banks were also required to place ontheir websites the grievance redressal procedureand the timeframe for responding to thecomplaints. If a complainant does not getsatisfactory response from the bank within thestipulated time from the date of lodging thecomplaint, the complainant has the option ofapproaching the Banking Ombudsman concernedfor the redressal of grievances.

2.147 Banks were further advised thatcompliance with ëKYCí norms will continue to be

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their responsibility. Since the objective is to extendsavings and loan facilities to the underprivilegedand unbanked population, banks were advised toadopt a flexible approach within the parametersof guidelines issued on ëKYCí from time to time.

2.148 In order to ensure that the banking facilitiespercolate to the vast sections of the population,banks were advised in December 2005 to makeavailable all printed material used by retailcustomers, including account opening forms, pay-in-slips, passbooks etc., in trilingual form, i.e.,English, Hindi and the concerned regional language.

2.149 With a view to providing hassle-free creditto banks customers in rural areas, the guidelineson general credit card (GCC) were issued onDecember 27, 2005 (Box II.23).

2.150 In order to prepare a monitorable actionplan for achieving greater financial inclusionand providing of financial services in the NorthEastern Region (NER), the Reserve Bank hadset up a Committee (Chairperson: Smt. Usha Thorat)in January 2006 to: (i) review the action takenso far for extending banking coverage and increasingthe flow of credit in the NER; (ii) identifyingbott lenecks in the extension of f inancialservices; (iii) suggest measures to overcome theimpediments in financial inclusion and enablegreater flow of credit, draw up state-wise actionplan appropriate to local conditions in each ofthe States; and (iv) consider matters relevant

Box II.23: General Credit Card (GCC) Scheme

Credit cards are now being extensively issued to and usedby individuals to make purchases of goods and serviceson credit and make cash withdrawals. In rural areas, withlimited point-of-sale (POS) and limited ATM facilities,while similar product may not be feasible, there has beendemand for General Credit Card (GCC) akin to KisanCredit Card (KCC). Consequently, banks and RRBs werepermitted to introduce a GCC scheme at any of theirbranches for issuing GCC to their constituents in ruraland semi-urban areas, based on the assessment of incomeand cash flow of the household similar to that prevailingunder normal credit card.

The objective of the scheme is to provide hassle free creditto banksí customers based on the assessment of cash flowwithout insistence on security, purpose or end-use of thecredit. This is in the nature of overdraft or cash-credit withno end-use stipulations. The credit facility extended underthe scheme will be in the nature of revolving credit. TheGCC holder will be entitled to draw cash from the specifiedbranch of a bank up to the limit sanctioned. It is notnecessary that GCC should be linked to purchase; GCC may

not necessarily be in the form of a card. GCC can be issuedin the form of a pass book, if the holder of GCC desires tooperate cash withdrawals from bank branch.

Banks would have flexibility in fixing the limit based onthe assessment of income and cash flow of the entirehousehold. However, the total credit facility under GCC foran individual should not exceed Rs.25,000 and interest rateon the facility may be charged, as considered appropriateand reasonable. The limit may be periodically reviewed andrevised/cancelled depending on track record of the accountholder. The eligibility criteria are subject to review. With aview to targeting women as beneficiaries of bank credit,they may be given a preferential treatment under the GCCscheme. Banks may utilise the services of local post offices,schools, primary health centers, local governmentfunctionaries, farmersí association/club, well-establishedcommunity-based agencies and civil society organisationsfor sourcing of borrowers for issuing GCC.

Fifty per cent of credit outstanding under GCC up toRs.25,000 will be eligible for being treated as indirectagricultural financing.

to the above and recommend appropriateactions on them.

2.151 The Committee, which submitted itsreport in July 2006, made severalrecommendations with a view to achieving greaterfinancial inclusion in the NER. Some of the majorrecommendations made by the Committeeinclude: (i) banks should draw up plans for eachbranch for providing ëno frillsí account to at least50 households per month in the next 4 years toachieve greater financial inclusion; (ii) banksshould undertake extensive recourse to bank/SHG-linkage programme and business correspondent/business facilitator model and IT based solutionsincluding smart cards based and mobile paymentsfor carrying out banking transactions from non-bank locations; (iii) simplified alternatives suchas land possession certificate/certificate from thegroup/local tribal bodies/farmers clubs/VillageDevelopment Boards regarding the borrowersíright to cultivate land, be adopted, given thatcommunity ownership and non-transferable rightson land often lead to problems in offering land ascollateral; (iv) location specific activity-wise actionplans be implemented for stepping up flow ofcredit to agriculture, allied activities and the SMEsector; (v) the ad hoc incentive package of humanresource management be replaced by performancebased cash incentive; and (v) the currencymanagement and payments/settlement system inthe region be improved.

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Box II.24: Working Group on Improvement of Banking Services in Uttaranchal

The major recommendations/observations of the Group(Chairman: Shri V. S. Das) are as follows:

ï There is a slowdown in investment credit, which hasimpaired agricultural borrowersí credit absorptioncapacity and eventually affected the growth of crop loansas well. Banks should integrate the investment andproduction credit needs of the farmers and increasetheir investment credit.

ï In view of a large number of small and fragmented landholdings, banks need to adopt cluster financing andsubsequently sub-clusters could be developed aroundthe main cluster.

ï In view of engagement of women in farm activities,suitable mechanism may be worked out to enable themto avail credit from the banking system.

ï In order to financially include 100 per cent of theunprivileged population, each bank branch may covera minimum of 25 new households per month over aperiod of three years, with a basic banking ëno frillsíaccount and limited overdraft facility through GCC/KCCeither directly or through SHGs.

ï Banks need to have CREDIT PLUS approach in theirfinancial inclusion schemes by extending insurance,marketing and consultancy services.

ï Considering the time, distance and cost for customersto reach a bank branch, especially in remote areas,banks need to use business facilitator and businesscorrespondent models for increasing their bankingoutreach to underserved/unbanked persons by using theservices of local persons like school teachers, postmen,primary health workers, as also of NGOs/MFIs/ CSOs.

ï Having regard to the trusted relationship that the peoplehave with post offices and postmen, banks couldgainful ly appoint post of f ices as their business

correspondents on the lines of Maharashtra model forachieving the ultimate target of 100 per cent financialinclusion.

ï With a view to providing financial literacy and awarenessof banking facilities to the people living in far-flung ruraland hilly areas, an awareness campaign through media,newspapers, road shows, street plays, audio visualsduring major festivals, needs to be launched. SLBCconvenor banks may take a lead with the help of othermajor PSBs and the State Government.

ï Village panchayats may be groomed to (i) act as bankingservices facilitation centre at each village to act as a linkbetween the bank servicing the region and the residentsof the village; and (ii) promote banking services and resolvesavings and credit needs of the residents of the village.

ï For greater outreach of banking services in remote areas,financial information network and operations (FINO)model, a technology backbone company for providingfacilities akin to banking to the grass root financialentities serving people who do not have access tobanking facilities, could be adopted. FINO has alreadyoffered their assistance in five districts of the State ona pilot basis.

ï To give more autonomy to the boards of RRBs, therequirement of obtaining prior approval from thesponsor bankís in staff requirement matters may bedispensed with. Each RRB should evolve its ownoperational policies, including staff matters. Pendingrecruitment of staff, the problem of staff shortage maybe addressed by deputation of staff from concernedsponsor banks.

ï Banks having larger share of foreign exchange businessin the State may make arrangements for providingforeign exchange facilities at all district headquartersand other strategic locations.

2.152 Pursuant to the meeting held between theGovernor of the Reserve Bank and the ChiefMinister of Uttaranchal, a Working Group(Chairman: Shri V. S. Das) was constituted on May22, 2006, to examine the problems/issues relatingto banking services in Uttaranchal and preparean action plan for implementation for the purpose(Box II.24).

2.153 The banking sector plays an important rolein the economic development of a country bymobilising savings and allocating them efficiently.However, banking penetration in India has beenlow. There are also wide variations of bankingpenetration across the States. With a view toundertaking a detailed study on bankingpenetration in India and recommending measuresto achieve higher banking penetration in the

country, a Working Group (Chairman: Shri JanakRaj) has been constituted. The Group is expectedto submit the Report by December 2006.

9. Payment and Settlement Systems2.154 The smooth functioning of the paymentand settlement system is a pre-requisite forfinancial stability. The Reserve Bank, therefore,has taken several measures from time to time todevelop the payment and settlement system in thecountry along sound lines. The initiatives takenduring the year include: (i) enhancing usage ofthe RTGS system; (ii) providing incentives andguidelines for reducing transaction costs forelectronic payment system: (iii) improvinglegal infrastructure for the payment system;(iv) introducing nationwide payment system for

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retail payment; (v) improving internationalremittance services; and (vi) facilitating newerchannels of payment and settlement (for detailsrefer to section 7 of Chapter III).

2.155 The Board for Regulation and Supervisionof Payment and Settlement Systems (BPSS), setup in March 2005 as a committee of the CentralBoard of the Reserve Bank, is the apex body forgiving policy direction in the area of payment andsettlement systems. The BPSS, which held sixmeetings since its constitution, gave importantpolicy directions/decisions. These include:(i) setting target for usage of the RTGS system;(ii) publishing frequently asked questions (FAQ)on payment systems; (iii) publishing the chargeslevied by banks for electronic payment systems;(iv) setting up an umbrella organisation for all retailpayment systems in the country; (v) finalising thePayment and Settlement Systems Bill; and(vi) preparing the Electronic Funds TransferRegulations under the Reserve Bank of India, Act.

2.156 The use of Electronic Clearing Service(ECS), both debit and credit, is on the increase.However, it is the debit clearing which is growingat a faster pace. The reach of ECS has increasedand it is now available at 58 centres. In November2005, banks were advised to develop appropriatedelivery channels of electronic payment servicesusing the payment systems developed by theReserve Bank such as RTGS, ECS, Electronic FundTransfer (EFT) and National Electronic FundTransfer (NEFT) with no further delay. Banks,which fulfill the eligibility criteria for participationin RTGS, were invited to participate in the NEFT.In order to start a robust state-of-the-art nationwideECS covering more branches and locations withcentralised data submission system, SCBs(including co-operative banks) were advised tofurnish certain information indicating their levelof preparedness for the project as on June 27,2006. To take the effort further, all SCBs weredirected on July 4, 2006 to initiate steps forincorporating an appropriate mandate managementroutine for handling ECS (Debit) transactions.Earlier in terms of the guidelines issued on October17, 2005, banks were advised to provide details tothe customers in their Pass Book/AccountStatement regarding the credits affected throughECS. Banks were also advised to furnishinformation on pricing of services for productsbased on structured financial messaging solution(SFMS)/RTGS/SEFT/EFT/ECS infrastructure. With

effect from June 14, 2005, processing charges forall electronic transactions under EFT, SEFT andECS facility amounting to Rs.2 crore and above,were waived up to the period ended March 31,2007. This is in addition to the existing waiver ontransactions involving less than Rs.2 crore.

2.157 The operationalisation of the NEFT inNovember 2005 was a major step in the directionof setting up and operating a national levelpayment system. The NEFT is a secured network,which uses the SFMS messaging format withpublic key infrastructure (PKI) enabled digitalsignatures retail electronic payment system havinga nation-wide network. All the SEFT clearingbanks were advised to migrate to NEFT systemby December 15, 2005. With the implementationof NEFT, the SEFT system was discontinued fromFebruary 2006.

2.158 The Reserve Bank has also advised banksto adopt the centralised funds managementsystem (CFMS), which enables banks to transferfunds across its accounts with various offices ofthe Reserve Bank. At present, the system isavailable at six centres, viz., Mumbai, Delhi,Chennai, Kolkata, Hyderabad and Bangalore. Twomore centres are likely to be included in thesystem soon.

2.159 The Reserve Bank has also decided toimplement the National Settlement System (NSS)to facilitate better liquidity management by banks.The concept paper on NSS explaining settlementof clearing across the country at one location wasprepared. Feedback received from banks is beingprocessed and the implementation of the facilitywill be taken up shortly. To start with, the clearingsettlements arrived at the four metros would besettled through the NSS. In the second phase,settlement of clearing in other large cities wouldalso be carried out through the NSS.

2.160 For further improving the efficiency of thepaper-based system, a plan has been drawn upfor computerisation of clearing operations atcentres where there are more than 30 banks (apartfrom the 59 centres where magnetic ink characterrecognition (MICR) cheque processing centreshave already been set up). A few centres havealready computerised the clearing houseoperations using the magnetic media basedclearing system (MMBCS). Under this system, themember banks present their claims in the formof an electronic file, which gets processed on the

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computer. This enables arriving of settlementfigures within a quarter of an hour as comparedwith three or four hours under the manual system.

2.161 A set of Minimum Standards of OperationalEfficiency for MICR cheque processing centres hasbeen framed in order to ensure smooth operationsof the MICR cheque processing centres. Thestandards mainly relate to encoding of instruments,time schedule, operational procedures, speed andaccuracy of on-line reject repair (OLRR), checkingof settlement reports for supervisory signals,enabling banks to download reports/data on-line,reconciliation and business continuity plan. TheMICR cheque processing centres have to submitëself assessment reportí certifying adherence to theminimum standards for operational efficiency tothe Reserve Bank.

2.162 The implementation of Cheque TruncationSystem (CTS) is another effort for bringing inefficiency of paper-based system. To be introducedon a pilot project basis in the national capital regionof Delhi by end-December 2006, the CTS would berolled out in the rest of the country in phases. UnderCTS, paper instruments do not travel beyond thepresenting bank. It is up to banks to take a businessdecision on the point of truncating the cheque - atthe branch level or service branch or gateway level.The CTS enables banks to handle the paymentinstruments in an easier way. Customers also enjoythe benefit of encashing their cheques faster. Apartfrom reduction in transaction costs for banks aswell as customers, the full implementation of CTSwould make it possible to achieve T+1 clearingcycle (even T+0) as CTS is straight-through-processing and automated payment processingenabled. Moreover, with CTS, banks also have theadditional advantage of much reducedreconciliation problems and incidents of clearingfrauds. In order to ensure that banks are ready withthe desired infrastructure well in time, detailedguidelines were issued to banks on the hardware/communication requirements.

2.163 As indicated in the Payment System Vision- 2005-08, the IBA constituted a Working Groupto look into the setting up of a separate entity fortaking over of the operations of retail paymentsystems. On recommendations of the WorkingGroup, a company registered under Section 25 ofthe Companies Act is being set up.

2.164 The Clearing Corporation of India Limited(CCIL) set up by banks is the central counter party

(CCP) for clearing of transactions in Governmentsecurities and foreign exchange. The CCILoperates the G-Sec clearing while the settlementfor both the securities and funds takes place inthe Reserve Bank. CCIL acts as the CCP for allthe transactions and guarantees both thesecurities and funds legs of the transaction. DvP-III mode of settlement has been adopted, wherebyboth the securities leg and the fund leg are settledon a net basis. CCIL guarantees settlement oftrades on the settlement date by acting as a centralcounter party to every trade through the processof novation. Another large value segment operatedby the CCIL is the forex clearing. Every eligibleforeign exchange contract entered into betweenmembers, gets novated and is replaced by two newcontracts - between CCIL and each of the twoparties, respectively. The rupee leg is settledthrough the membersí current account with theReserve Bank and the USD leg through CCILísaccount with the designated settlement bank atNew York. The settlement through CCIL hasreduced the gross dollar requirement by morethan 90 per cent.

2.165 SCBs were advised to expedite the processof allotting Indian Financial System Code (IFSC)to the branches in March 2006. It was also decidedthat IFSC of the branch be printed just above theMICR band on the cheques preferably above theserial number of the cheque. In July 2006, it wasdecided that prior approval of the Reserve Bankwould not be required for offering internetbanking services, subject to fulfilment of certainconditions.

Remittances Services

2.166 The cross border remittances are mainlyfrom migrant workers to their families in their homecountry. However, the remittances can be expensiverelative to the often low income of migrant workersand to the rather small amounts sent. A Task Forcewas constituted by the Committee on Payment andSettlement System (CPSS) of the Bank forInternational Settlements (BIS) to developprinciples for international remittance services.Based on the recommendations of the Task Force,the CPSS published a Consultative Report onGeneral Principles for International RemittanceServices in March 2006. The General Principles areaimed at the public policy objectives of achievingsafe and efficient international remittance services(Box II.25).

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Box II.25: Consultative Report on General Principles for International Remittance Services

The main principles laid down in the Consultative Reportare set out below:

General Principle 1: The market for remittance servicesshould be transparent and should have adequate consumerprotection.

General Principle 2: Improvements in payment systeminfrastructure, that have the potential to increase theefficiency of remittance services, should be encouraged.

General Principle 3: Remittance services should besupported by a sound, predictable, non-discriminatory andproportionate legal and regulatory framework in relevantjurisdictions.

General Principle 4: Competitive market conditions,including appropriate access to domestic payments

infrastructure, should be fostered in the remittanceindustry.

General Principle 5: Remittance services should besupported by appropriate governance and risk managementpractices.

Remittance service providers should participate actively inthe implementation of the General Principles. Publicauthorities should evaluate what action is required to betaken to achieve the public policy objectives throughimplementation of the General Principles.

Reference :

Bank for International Settlements (2006): ConsultativeReport on General Principles for International RemittanceServices, March.

2.167 An internal study revealed that a majorportion of the remittances received (54 per cent)was utilised for family maintenance. On anaverage, about 20 per cent of the funds receivedwere deposited in the bank accounts and 13 percent were invested in land/property/equity shares.A cross-section analysis of the relationshipbetween the size of remittances and the frequencyof sending remittances revealed an inverserelationship between the two, which is in line withthe empirical findings of studies in otherdeveloping countries. The Study found that thereis a preference for time-efficient modes such aselectronic wires/swift by the overseas Indians,even though they turn out to be costlier ascompared with drafts and cheques.

2.168 The Working Group on the Cost of Non-Resident Indian (NRI) Remittances submitted itsReport to the Reserve Bank in August 2006. Someof the major recommendations made by the Groupinclude: (a) banks in India should review theirexisting scale of charges both at the foreign andthe domestic centres and resort to latesttechnology for handling large volume oftransactions; (b) banks should improve theirinfrastructure by extending the scope of existingelectronic transfer facilities such as the RTGS orsetting up centralised remittance receiving centresand widening the scope of exchange houses;(c) Indian banks should explore tie-ups with morecorrespondent banks which would bring down thecost for the NRIs at the foreign centres; (d) thecap on number of branches of Indian banks withdrawal arrangements with exchange houses maybe reviewed; and (e) NRIs may be advised to route

their remittances through a branch of an Indianbank or a foreign bank having a branch in India.NRIs should be advised, as far as possible, toconvert foreign currencies into Indian Rupees atthe Indian end to get the benefit of a betterexchange rate.

10. Technological and Other Developments

2.169 The financial sector has been a large userof information technology (IT). Banks, in particular,have been increasingly using IT in their day to dayoperations. Over the years, banks have (a) extendedthe reach of core banking solutions (CBS) to morebranches so as to facilitate ëanywhere bankingí; (b)introduced technology based products and servicessuch as mobile banking; and (c) expanded theinternet banking facilities. Banks have beenincreasingly using the NEFT for ensuring widerreach for electronic funds movement.

2.170 With enhanced level of IT usage by banks,the Reserve Bank is gradually moving away frommicro-management of IT related matters of banks.Instead, the Reserve Bank has begun to frameguidelines and standards which relate to commoninter-bank requirements. During the year, theFinancial Sector Technology (FST) Vision Document,2005-08 was released to all banks in July 2005. Thedocument outlines the approach to be followed bythe Reserve Bank as far as IT implementation forthe immediate future is concerned. The VisionDocument has helped banks to formulate their ITpolicies in a manner which are in line with thedirection given by the Reserve Bank. At the sametime, it also facilitated banksí overall movement in

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a unified manner towards common inter-operablestandards for IT systems and inter-bank messaging.In order to follow-up the implementation of thetenets of the FST Vision Document, a Conferenceof IT Chiefs of all categories of banks was organisedby the Reserve Bank in January 2006.

Technology Based Services provided by theReserve Bank to Banks

2.171 The Reserve Bank continued to functionas a business facilitator for developing newproducts and services by banks. Some of thesystems developed by the Reserve Bank for useby banks were NDS, RTGS, CFMS and SFMS overthe INFINET.

2.172 Improvements in the software architectureof NDS have resulted in better throughput andreduced processing time for member banks of thesystem. A major enhancement made during the yearwas the migration towards front-end validation bythe member instead of validation being performedby the host. The system functioned smoothly duringthe year. The process of converting the system intoa screen based trading system was completed. Thefirst set of modules was made operational at the CCILfrom August 2005.

2.173 The RTGS system has stabilised well andthe use of the facility for transfer of funds,especially for large value and for systemicallyimportant purposes, has been on the rise. Thesystem has a ëYí topology and the number ofmembers using the system has gone up to 110with nearly 25,000 bank branches offering RTGSbased fund transfers to their customers.

2.174 During the year, the transmission of clearingdata, both for cheque clearing and for electronicclearing services, was done in many centres throughthe secured website. In addition, collation of inputsfrom currency chests as part of the integratedcurrency chest operations and management system(ICCOMS) was done using the secured website. Thesecured internet website was extended to cover thecentralised data base management system (CDBMS)and for commercial banks to access clearing datafor STP based posting. The software systemdeveloped for the BO in September 2005 also usesthe secured website as the means of informationtransmission. This system facilitates monitoring ofcomplaints not only by the offices of the BO situatedat various locations but also by the Reserve Bankand the Ministry of Finance.

Banks and IT based Delivery Channels

2.175 Over the past few years, the banking sectorhas witnessed a large increase in the use of IT baseddelivery channels and internet banking activity. Someof the new facilities provided include: (i) fundstransfer options to cover third party customeraccounts within the same bank; (ii) funds transferacross banks; (iii) utility bill payments and otherregular periodical payment facil it ies; and(iv) integration with e-commerce transactions suchas for booking of tickets for rail and air.

2.176 Banks were advised in July 2006 not toassociate themselves with internet based electronicpurse schemes, which are in the nature of acceptanceof deposits withdrawable on demand.

2.177 Mobile banking is another activity, which isgaining ground. Many customer-friendly facilitiesfrom short messaging service (SMS) alerts to actionbased on mobile instructions are being incorporated,which could have far reaching implications for thefinancial sector. The delivery channels such asinternet and mobile banking, however, also raisesome concerns about the security (Box II.26).

Developments in the INFINET

2.178 The Indian Financial Network (INFINET)continued to be the most preferred communicationchannel for transmission of electronic informationby banks for the systemic inter-bank paymentsystems of the Reserve Bank. INFINET is beingused by banks for inter-office communication aswell. INFINET uses the SFMS, which is a messageprocessing system similar to the Society forWorldwide Financial Telecommunication (SWIFT)messaging system. SFMS is PKI enabled so as toprovide for security of highest levels for secureand safe inter-bank financial message transfers,apart from conforming to the laws of the land suchas the Information Technology Act, 2000. SFMSbased message transfers can conform to therequirements of straight through processing (STP)so as to ensure quick, safe and secure processingwith little or no interference by humans. TheINFINET is a wide area terrestrial and satellite[using very small aperture terminals (VSATs)]based blended network. The terrestrial links areprovided by means of leased optical fibre channelswith adequate bandwidth. The network operatedand managed by the Institute for Development andResearch in Banking Technology (IDRBT), ispoised to be used for connectivity options available

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Box II.26: Security in Delivery Channels

Banking in India has witnessed a large scale transformationin the last few years. Some of the new technology-baseddelivery channels implemented by banks for their customersinclude internet banking, mobile banking and card basedfunds transactions. In all these products, the underlyingmedium of information transportation is generally acommonly available, inexpensive and public oriented vehiclesuch as internet or mobile telephony.

Given the need for optimal levels of security for financialtransactions, the enhanced security of technology-basedtransactions assumes significance. The Reserve Bank hadissued guidelines for internet banking in 2001, whichcontinue to be the baseline set of requirements for banks tofollow when they offer internet banking services to theirclients. However, technological developments combined withthe increase in unethical attempts to break into systems havewarranted a continuous review of the security implementedin such systems.

A set of preventive, detective and control measures arenecessary for enhanced customer confidence in internetbanking. Apart from base level security features such as userIDs (identification) and passwords, other security facilitatorssuch as firewalls, proxy servers and customer heldidentification devices could also be used. Authentication isanother basic requirement which is implemented by the use

of public key infrastructure (PKI) based encryption,biometric and/or other devices. Trust, which is achieved byreputed and independent third parties confirming theauthenticity/genuineness of transactions/messages is beingachieved in the Indian case by the use of digital signatureswhich are issued by certification/registration authoritiesunder the Information Technology Act, 2000. Non-repudiation,which prevents denial or repudiation by the sender and receiverof electronic messages, privacy and availability are of utmostimportance for building customer confidence.

Other requirements such as confidentiality, virus detectionand prevention, disaster recovery management andbusiness continuity plans need to be taken care of ininternet banking offerings, in addition to regular periodicaltests of the sites access facilities provided, audit of thepersonnel associated with the process and other similarcritical aspects such as an overview of the types of serviceaccess.

Some of the recent initiatives undertaken to address potentialsecurity risks for mobile banking and home content accessare: (i) smart phone access based on SIM authentication;(i i) (RF)ID (Radio -Frequency Identif ication) basedauthentication, based on SIM stored user name/password;(iii) PC based access with user name/password; and (iv) PCbased access through mobile phone presence.

in the form of virtual private networks (VPNs) overpublic network. Banks in India have beenencouraged to use their own networks for inter-branch communications. With internet basedelivery channels becoming easily available, theconcept of VPNs is gaining ground amongst banks

Box II.27: Virtual Private Networks

Network based communication and computation have comeof age. From a period characterised by users having theirown networks, today, the internet has become the mostpreferred mode of electronic communication. The migrationtowards centralised processing systems, the large scaleproliferation of the internet and low costs have resulted inincreased usage of public networks. This has been achievedwith enhanced security, wherever required.

A Virtual Private Network (VPN) is a network made up ofpublic communication links and using the internet as themedium for transporting electronic information. A VPN is aprivate network within a public network to connect remotesites or users together. It facilitates transmission of messagesamongst the members of the VPN in an encapsulated mannerso that unauthorised access to these messages is notpossible. VPNs use enhanced security features to ensure thatauthorised users only have access to the network and thatdata travelling over the network cannot be intercepted. Thus,the key differentiator in a VPN is the security on suchnetworks. Security on VPNs is achieved by the use ofcryptographic tunnelling protocols to provide the necessary

confidentiality, sender authentication and message integrityto achieve the privacy intended. When properly chosen,implemented and used, such techniques can provide securecommunications over unsecured networks. Such securityrequirements are ensured from a service provider by meansof a defined service level agreement (SLA) between thecustomer and the service provider.

Some of the advantages of resorting to a VPN include a largergeographical coverage, enhanced security, reduced costs,quick transmission time for message transfers and arelatively simpler network topology.

A well-designed and implemented VPN incorporates the keyessential features of security, reliability, scalability andoptimal network management. A VPN involves two parts: (i)the protected or ìinsideî network, which provides physicaland administrative security to protect the transmission; and(ii) a less trustworthy, ìoutsideî network or segment, whichis generally the internet. Generally, a firewall sits between aremote userís workstation or client and the host network orserver. An example of a financial VPN is the SWIFT, whichhas migrated to the secure electronic messages using VPNs.

in India as well. A few banks have set up theirown corporate networks using VPNs. Anothernotable feature during the year was the migrationof SWIFT to IP based network, with extensive usageof VPNs. This has instilled greater level ofconfidence amongst the banks (Box II.27).

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11. Legal Reforms in the Banking Sector

2.179 An efficient financial system requires aregulatory framework with well-defined objectives,adequate and clear legal framework and transparentsupervisory procedure. A comprehensive legislationis also a pre-requisite for the regulatory authority todischarge its responsibilities effectively. Keeping thisin view, the Reserve Bank has been making constantefforts to upgrade and strengthen the legalframework in tune with the changing environment.The Central Government, on the recommendationof the Reserve Bank, has initiated a number ofmeasures in this respect over the past few years.

Recent Acts Enacted by the Parliament

2.180 In order to facilitate the task of monetarymanagement and provide operational flexibility,a greater empowerment of the Reserve Bank inthe wielding of policy instruments was considerednecessary. Keeping this in view, the Reserve Bank

of India Act, 1934 was amended by the Parliament.This amendment, inter-alia, has empowered theReserve Bank to determine the CRR without anyceiling or floor rate (Box II.28).

2.181 The Credit Information Companies(Regulation) Act, 2005 has been enacted forregulation of Credit Information Companies andfacilitating efficient distribution of credit and formatters connected therewith or incidental thereto.After coming into force of the Act, the existingobligation, on the part of credit institutions suchas banks and FIs, to maintain secrecy with respectto affairs of their constituents would not be a legalconstraint for them. The Act provides forestablishment, supervision and regulation of acredit information company that can undertakethe functions of collecting, processing andcollating information on trade, credit and financialstanding of the borrowers of credit institutionswhich are members of the credit informationcompany. It could provide credit information to

Box II.28: The Reserve Bank of India (Amendment) Act, 2006 ñ Salient Features

The Reserve Bank of India (Amendment) Act, 2006, givesenabling powers to the Reserve Bank with regard toinstruments for monetary management. The amendmentmainly provides flexibility to the Reserve Bank in prescribingreserve requirements for scheduled banks and also givescomprehensive powers to regulate the money and thegovernment securities market.

(i) Cash Reserve Ratio

Under the amended statute, the Reserve Bank, in order tosecure monetary stability in the country, can determine theCRR for scheduled banks without any ceiling or floor rate.With the amendment of the Act, the Reserve Bank also cannotpay interest on any portion of CRR balances of banks oncethe Act comes into force. Prior to the amendment, the ReserveBank did not pay interest on CRR balances on the statutoryminimum level of 3 per cent of banksí demand and timeliabilities. Also, no interest was paid on excess CRR balancesmaintained by the banks beyond the prescribed level.

(ii) Reverse Repo and Repo

The amended Act enables the Reserve Bank to undertakerepo and reverse repo operations as also lending andborrowing of securities, including foreign securities.

The amendments have implications for the businessundertaken by the Reserve Bank on its own account. Further,the insertion in clause (12A) defines repo/reverse repo asessentially collateralised borrowing/lending transactions ineither cash or securities that are structured as sale purchasetransactions, with the securities passing from seller to buyerin the ready leg and back to seller in the forward leg. Untilthe amendment, the accounting treatment of repo reflectedthe legal interpretation of repo as sale/purchase transactions.The amended provisions define repo/reverse repo as two legs

of the same transactions and not two discrete/independenttransactions.

(iii) Money and Government Securities Market

The new Chapter (III-D) of the amended Act empowers theReserve Bank to determine the policy relating to interestrates or interest rate products and regulate the agenciesdealing in securities, money market instruments, foreignexchange, derivatives, or other instruments of like nature,give directions, and also call for information and causeinspection of entities that are otherwise not under theregulatory purview of the Reserve Bank. As such, the ReserveBankís permission would be required for exchange-tradedderivate products if the underlying is foreign exchange,interest rate, credit or a combination of these. Policyguidelines on interest rate futures and issues relating to repoin corporate bonds would also be under the Reserve Bankíspurview. Prior to the amendment, the Reserve Bank regulatedthe transactions in money markets and other instrumentsunder the powers delegated to it by the Central Government.

(iv) Derivatives

The insertion of a new clause in the Act would allow the ReserveBank to deal in derivatives which may have interest rate,securities (including foreign securities), indices of rates or prices,foreign exchange rate, credit rating or index and/or the price ofgold or silver coins, gold or silver bullion or any other financialinstrument as its underlying value variables.

The amendments give legal sanctity to over-the-counter(OTC) derivatives if at least one of the parties to thetransaction is the Reserve Bank or any agency falling underits regulatory purview. Prior to the amendment onlyexchange-traded derivatives were valid. Other contractscould be settled under the Contract Act, 1872.

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its specified users. The Rules and Regulations forthe purposes of carrying out the provisions of theAct are pending consideration of the Government.

2.182 The Government Securities Act, 2006proposes to consolidate and amend the lawrelating to issue and management of Governmentsecurities by the Reserve Bank. The Act providesfor: (i) empowering the Reserve Bank to prescribethe form for transferring Government securities;(ii) holding of Government promissory notes bytrusts; (i i i) simplifying the procedure forrecognising title to Government securities up toRs.one lakh with enabling power to the CentralGovernment to enhance the said limit up to Rs.onecrore; (iv) allowing micro films, facsimile copiesof documents, magnetic tapes and computerprintouts to be admissible as evidence; and(v) suspension of the holders of subsidiary generalledger account from trading with the facility ofthat account in the event of misuse of the saidfacility. Other salient features of the Act include:(i) enabling creation of pledge, hypothecation orlien in respect of Government securities; and(ii) empowering the Reserve Bank to call forinformation, conduct inspection and issuedirections as well as make regulations, with theprevious approval of the Central Government, forcarrying out the purposes of the Act. The Act isyet to be brought into force.

2.183 The Banking Companies (Acquisition andTransfer of Undertakings) and FinancialInstitutions Laws (Amendment) Act, 2005 mainlyseeks to amend the Banking Companies(Acquisition and Transfer of Undertakings) Act,1970 and the Banking Companies (Acquisitionand Transfer of Undertakings) Act, 1980. The Bill,inter alia, provides for: (i) electing one to threeshareholder directors on the boards of thenationalised banks on the basis of issued capitalof the bank instead of one to six directors underthe existing provisions so as to provide for a moreequitable representation on the Board based onthe percentage of ownership; (ii) modifying theprovisions relating to nomination of directors bythe Reserve Bank on the boards of nationalisedbanks; (iii) conferring power upon the ReserveBank to appoint one or more additional directors;(iv) empowering the shareholders of nationalisedbanks to discuss, adopt and approve theDirectorsí report, the profit and loss account andbalance sheet of the bank at the annual generalmeeting; (v) enabling the banks to transfer theunclaimed dividends for more than seven years

to Investor Education and Protection Fundestablished under section 205 C of the CompaniesAct, 1956. The Act also provides for: (i) enablingnationalised banks to issue preference shares inaccordance with guidelines framed by the ReserveBank and to raise capital by preferential allotmentor private placement or public issue with theapproval of the Reserve Bank and the CentralGovernment; (ii) restricting the voting rights ofpreference shareholders to resolutions directlyaffecting their rights and up to a maximum of oneper cent of the total voting rights of all theshareholders holding preference share capital only;(iii) ëfit and properístatus for the elected directors;and (iv) supersession of Board by the CentralGovernment on the recommendation of the ReserveBank and appointment of an administrator and aCommittee to assist the administrator. The Actcame into force with effect from October 16, 2006.

Bills introduced in the Parliament

2.184 The Banking Regulation (Amendment) Bill,2005, introduced in the Lok Sabha on May 13,2005, seeks to amend some of the provisions ofthe Banking Regulation Act, 1949 with a view tostrengthening the regulatory powers of the ReserveBank. The Bill includes provisions for: (i)removing the restriction on voting rights andintroducing the requirement of prior approval ofthe Reserve Bank for acquisition of shares orvoting rights above the specified limit (empoweringthe Reserve Bank to satisfy itself that the applicantis a ëfit and proper personí to acquire shares orvoting rights and to impose such furtherconditions that the Bank may deem fit to impose);(ii) removing the lower limit (floor) of SLR andempowering the Reserve Bank to specify the SLRsubject to a maximum of forty per cent of thetotal demand and time liabilities; (iii) amendingthe definition of approved securities in Section5(a) of the Act to empower the Reserve Bank tospecify from time to time any security, in additionto securities issued by the Central or the StateGovernment, as ëapproved securitiesí; (iv) amendingSection 12 of the Act to enable bankingcompanies to issue preference shares, subject toregulatory guidelines framed by the ReserveBank; (v) empowering the Reserve Bank to directa banking company to disclose in its financialstatement or furnish separately such statementsand information relating to the business of anyassociate enterprise, as the Reserve Bankconsiders necessary and also to cause an

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inspection to be made of any associate enterprise;(vi) empowering the Reserve Bank† to supersedethe board of directors of a banking company andappoint an administrator; (vii) amending Section56 of the Act to remove the provision whichallowed facilitating primary credit societies tocarry on the business of banking withoutobtaining a license from the Reserve Bank; and(viii) empowering the Reserve Bank to orderspecial audit of a co-operative bank in publicinterest or in the interest of the co-operative bankor its depositors.

2.185 The Securities Contracts (Regulation)Amendment Bill, 2005 seeks to amend theSecurities Contract (Regulation) (SCR) Act, 1956so as to provide a legal framework for trading insecuritised debt including mortgage backed debt.The Bill proposes, inter alia, (i) to includesecuritisation certificate or instrument under thedefinition of ësecuritiesí and to insert for the saidpurpose, a new sub-clause in clause (h) of section2 of the SCR Act, 1956; and (ii) to provide forobtaining approval from SEBI for issue ofsecuritisation certificate or instrument andprocedure thereof, and to insert for the purpose,a new section 17 A in the SCR Act, 1956.

2.186 The Central Government has introducedthe State Bank of India (Subsidiary Banks Laws)

Amendment Bill, 2006 in the Lok Sabha toamend the laws governing subsidiary banks (ofthe State Bank of India) to enhance the capitalof the subsidiary banks. This will enable thesubsidiary banks to raise resources from themarket and to provide f lexibil i ty in themanagement of these banks.

2.187 The Payments and Settlements Bill, 2006was introduced in the Lok Sabha on July 25,2006. The Bill seeks to designate the ReserveBank as the authority to regulate payment andsettlement systems. The Bill contains provisionsfor: ( i ) compulsory requirement of anauthorisation by the Reserve Bank to operatepayment systems; (ii) empowering the ReserveBank to regulate and supervise the paymentsystems by determining standards, calling forinformation, returns and documents; (iii) conferringpower on the Reserve Bank to audit and inspectby entering the premises where payment systemsare being operated; (iv) empowering the ReserveBank to issue directions; (v) providing forsettlement and netting to be final and irrevocableat the determination of the amount of money,securities or foreign exchange payable byparticipants; and (vi) overriding other laws. TheBill has since been referred to the StandingCommittee on Finance.

5. supervision and supervisory policy board for financial

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