twitter

google+

Part II. Mid-termReview of Annual Statement on Developmental and Regulatory Policies for theyear 2005-06

54. The annualpolicy Statements as well as mid-term Reviews of the Reserve Bank have progressivelysharpened the focus on developmental and regulatory policies to strengthen thefinancial system with a view to ensuring financial stability as a prerequisitefor high and stable growth. Rapid changes in technology and the impact ofglobalization have necessitated prudent and forward-looking policy initiativesfor the maintenance of financial stability. The Reserve Banks approach hasbeen to reorient its role in the context of the evolving conditions forimproving institutional soundness, strengthening the regulatory and supervisoryprocesses and developing the necessary legal and technological infrastructure.

While the functions of financial sector regulation and supervision emphasizeefficiency, stability and soundness of regulated entities and markets, theyalso aim at developing a system that is responsive to the needs of all sectionsof society.In this context, the Reserve Bank is continually broadening itsconsultative and participative process for wider involvement of allstakeholders in the financial system with a view to encouraging a more informedevaluation of the underlying content of policies.

55. In the contextof entrenching financial stability in India, the mid-term Review focuses oncertain key areas. First, it is essential to take adequate measures forenhancing delivery of appropriate credit at a reasonable price. Second, thereis a need to further develop financial markets and enhance the integration ofvarious segments of the financial markets with proper checks and balances. Third,within the emphasis assigned to credit delivery to agriculture and the smalland medium enterprise (SME) sector, developing a conducive environment formicro-finance institutions (MFIs) to cover financial services in addition tocredit requires specific attention. Fourth, with a view to ensuring financialinclusion of all segments of the population, in both rural and urban areas, acomprehensive framework to revive the co-operative credit system, revitalisethe regional rural banks (RRBs) and reorient commercial banking towards thecredit-disadvantaged sections of society assumes high priority. Finally, inorder to safeguard systemic stability, sound corporate governance practices,sophisticated risk management techniques and implementation of prudentialmeasures in the financial sector in harmony with global developments need to befocused on. In this regard, there is some merit in assessing the prudentialguidelines in the light of developments in business cycles and systems ofpricing of risks in different segments. Managing risk-based capital requirementand ensuring robustness of the risk management as well as risk-pricing systemsassume importance.

56. The mid-termReview of the Annual Statement on Developmental and Regulatory Policies for theyear 2005-06 assesses the progress of measures already taken and proposes somefurther measures under five sections:

I. Interest Rates

Interest RatePolicy

57. The annualpolicy Statement of April 2005 recognized that there is merit in furtherderegulation of interest rates in those segments, which have remained regulatedfor reasons relevant at different stages. It proposed, however, to continuewith the status quo as various issues pertaining to regulations oninterest rates were being debated. In this context, the Reserve Bankconstituted an Internal Working Group on NRI Deposits, which submitted itsreport in September 2005. Furthermore, the Indian Banks Association (IBA) hasbeen requested to constitute technical groups for preparation of discussion paperson review and deregulation of interest rate on savings bank deposits andlending rates on small loans up to Rs.2 lakh.

BPLR System: Review

58. Pursuant to theannouncement made in the mid-term Review of November 2003, the IBA advised itsmember banks to announce a benchmark prime lending rate (BPLR), with theapproval of their boards, keeping in view the operational requirements.Furthermore, banks were allowed to freely price their loan products below orabove their BPLR and offer floating rate products by using market benchmarks ina transparent manner. Banks were also encouraged to align the pricing of creditto their credit risk assessment so that both credit delivery and qualityimproves.

59. Over the period,however, the system of BPLR has evolved in a manner that has not fully metthese expectations. Competition has forced the pricing of a significantproportion of loans far out of alignment with BPLRs and in a non-transparentmanner. As a consequence, this has undermined the role of the BPLR as areference rate. Furthermore, there is a public perception that there is underpricing of credit for corporates while there could be overpricing of lending toagriculture and small and medium enterprises. Several requests have also beenreceived by the Reserve Bank from banks suggesting a review of the BPLR system.Therefore, a need has arisen to review the current procedures and processes ofpricing of credit through a well-structured and segment-wise analysis of costsat various stages of intermediation in the whole credit cycle. Accordingly, theIBA may, in consultation with its member banks, review the BPLR system afreshand issue transparent guidelines for appropriate pricing of credit.

II. FinancialMarkets

Money Market

Framework forDevelopment of Money Market

60. As indicated inthe annual policy Statement of April 2005, the report of the Technical Group onMoney Market was placed on the Reserve Banks website for wider dissemination.A screen-based negotiated quote-driven system for all dealings in call/noticeand term money markets and an electronic trading platform for conduct of marketrepo operations in government securities, in addition to the existingvoice-based system, are being developed by the Clearing Corporation of IndiaLtd. (CCIL). Furthermore, information on commercial paper (CP) issuance asreported by the issuing and paying agents (IPA) on the negotiated dealingsystem (NDS) platform, has been made available on the Reserve Banks websitewith effect from July 2005 to enhance transparency and facilitate widerdissemination. The recommendations of the Group on introduction of asset-backedcommercial paper (ABCP), introduction of additional intra-day LAF and optionalties in OTC rupee derivatives are under examination.

Government SecuritiesMarket

(a) CentralGovernment Securities Market

61. On the basis ofthe recommendations of the Technical Group on Central GovernmentSecurities Market, the annual policy Statement of April 2005 indicated that inthe post-Fiscal Responsibility and Budget Management (FRBM) Act period, theReserve Bank will reorient government debt management operations whilesimultaneously strengthening monetary operations in order to prepare forwithdrawing from primary financing of the Central Governments borrowing programme,effective April 2006. Accordingly, the Reserve Bank has constituted a newdepartment named as Financial Markets Department (FMD) in July 2005 with a viewto moving towards functional separation between debt management and monetaryoperations. To begin with, the functions of the FMD include open marketoperations (OMO), the liquidity adjustment facility (LAF), market stabilizationscheme (MSS) and standing liquidity facilities; regulation and development ofmoney market instruments and monitoring of money, government securities andforeign exchange markets. The functions of the FMD would also cover the ReserveBanks operations in the domestic foreign exchange market, in due course, inorder to achieve the desired integration with conduct of monetary operations.

62. Therecommendations of the Technical Group relating to restructuring theunderwriting obligations of primary dealers (PDs), allowing PDs exclusivity inprimary auctions, introduction of When Issued Market and limited shortselling in government securities were examined by the Reserve Bank inconsultation with the Government. Accordingly, as a first step, it is proposed:

to introduceintra-day short selling in government securities. Guidelines in this regardwould be issued separately.

(b)Operationalisation of Electronic Trading Platform

63. As indicated inthe annual policy Statement of April 2005, a screen-based order-drivenanonymous NDS Order Matching (NDS-OM) Module has been operationalised in August2005. In the first phase, the NDS-OM module has been introduced forRBI-regulated NDS members. By end-September 2005, 117 members were active inthe module with NDS-OM volumes covering about two-thirds of the total outrighttransactions in dated government securities in the secondary market. It is nowproposed:

to extend NDS-OMmodule to all insurance entities which are mandated to invest in governmentsecurities. Guidelines in this regard would be issued separately.

(c) Revision ofWMA/Overdraft Scheme for State Governments: Status

64. The Committee onWays and Means Advances (WMA) to State Governments (Chairman: Shri C.Ramachandran) had recommended inter alia that the formula and the limitsof WMA may be reviewed in totality after the receipt of the recommendations ofthe TFC. Accordingly, an Advisory Committee to Review the WMA Scheme wasconstituted in April 2005 (Chairman: Shri M.P. Bezbaruah). The Committee wouldsubmit its report shortly. The report would then be discussed with the StateGovernments.

Foreign ExchangeMarket

(a) Forex Market:Medium-term Framework

65. As indicated inthe annual policy Statement of April 2005, the report of the Internal Group onForex Market was placed on the Reserve Banks website for wider dissemination.The recommendations of the Group, particularly those on writing of coveredoptions by corporates, hedging of economic risk of corporates in respect oftheir domestic operations arising out of changes in the landed cost of theimported substitutes of the commodities they consume/produce and crystallisationof overdue export bills are under examination.

(b) ExternalCommercial Borrowings: Expansion

66. Currently,external commercial borrowings (ECBs) proposals of financial institutionsdealing exclusively with infrastructure or export refinance such as InfrastructureDevelopment Finance Company, Power Finance Corporation, Power TradingCorporation, Indian Railway Construction Company and Exim Bank are consideredby the Reserve Bank on a case-by-case basis under the approval route. It is

clarified that:

Special purposevehicles (SPVs) or any other entity notified by the Reserve Bank, which are setup to finance infrastructure companies/projects, would be treated as financialinstitutions and ECBs raised by such entities would be considered under the approvalroute.

67. With a view tofacilitating capacity expansion and technological up gradation in the Indiantextile units after phasing out of the Multi-Fibre Agreement, it is proposed:

Allowing banks toissue guarantees or standby letters of credit in respect of ECBs raised bytextile companies for modernisation or expansion of textile units. Suchapplications would be considered under the approval route subject to prudentialnorms.

III. Credit DeliveryMechanisms

(a) Flow ofCredit to Agriculture

68. It has been theendeavour of the Reserve Bank to improve the agricultural credit deliverymechanism to enable banks to provide adequate and timely finance at reasonablerates. As indicated in the annual policy Statement of April 2005, most of therecommendations of the Advisory Committee on Flow of Credit to Agriculture andRelated Activities from the Banking System (Chairman: Prof. V.S. Vyas) havebeen implemented by the Reserve Bank and the National Bank for Agriculture andRural Development (NABARD). A few recommendations of the Committee are underexamination of the Government. Public sector banks are required to formulatespecial agricultural credit plans (SACP) in order to achieve distinctimprovement in the flow of credit to agriculture. During 2004-05, disbursementsto agriculture by public sector banks under SACP aggregated Rs.65, 218 croreagainst the projection of Rs.55, 616 crore. By end-June 2005, public sectorbanks had issued 183.5 lakh kisan credit cards (KCCs) with aggregate limitsamounting to Rs.62, 000 crore. As announced in the Union Budget for 2005-06,the Rural Infrastructure Development Fund (RIDF) XI has been established withthe NABARD with a corpus of Rs.8, 000 crore. Cumulative sanctions anddisbursements till August 2005 under various tranches of RIDF (I to XI)amounted to Rs.44, 389 crore and Rs.26, 693 crore, respectively.

(b) PrioritySector Lending

69. It was indicatedin the annual policy Statement of April 2005 that prescriptions on eligibilitycriteria and other aspects relating to priority sector lending need to bereviewed and examined in depth. In this context, an Internal Working Group(Chairman: Shri C. S. Murthy) was set up by the Reserve Bank to review theexisting policy on priority sector lending including the segments constitutingthe priority sector, targets and sub-targets and recommend changes asnecessary. The draft technical paper of the Group has been placed on theReserve Banks website for wider dissemination and comments. The technicalpaper has also been sent to the Government and the IBA for their views.

(c) Credit Flowto Small and Medium Enterprises

70. As a sequel tothe announcement made by the Honble Finance Minister in the Parliament onAugust 10, 2005 in regard to a policy package for stepping up credit to smalland medium enterprises, banks were advised to take action as under:

Units withinvestment in plant and machinery in excess of the small scale industries (SSI)limit and up to Rs.10 crore would be treated as medium enterprises (ME) andonly SSI financing would be included in priority sector lending.

Banks would fixtheir own targets for financing the SME sector so as to reflect a higherdisbursement over the immediately preceding year, while the

sub-targets for financing tiny units and smaller units to the extent of 40 percent and 20 per cent, respectively, would continue.

Banks wouldinitiate necessary steps to rationalise the cost of loans to the SME sector byadopting a transparent rating system with the cost of credit linked to thecredit rating of the enterprise.

Banks should makeconcerted efforts to provide credit cover, to at least five new small/mediumenterprises per year on an average, at each of their semi urban/urban branches.

Boards of bankswould formulate liberal and comprehensive policies for extending loans to theSME sector.

Banks shouldincreasingly adopt the cluster-based approach for financing the SME sector.

Banks would ensurepresence of specialized SME branches in identified clusters/centres withpreponderance of medium enterprises to provide SME entrepreneurs easy access tobank credit and also equip their personnel with requisite expertise. Theexisting specialised SSI branches would also be redesignated as SME branches.Though their core competence will be utilised for extending finance and otherservices to the SME sector, they will also have operational flexibility toextend finance/render other services to other sectors/borrowers.

Policy guidelinesformulated by the boards of banks, all facilities/schemes offered by them tosmall entrepreneurs and instructions/guidelines issued by the Reserve Bankshould be displayed on the websites of banks, the SIDBI and at each bank branchfor wider dissemination and easy accessibility.

71. The Reserve Bankhas constituted empowered committees at its regional offices toreview the progress in SME financing and rehabilitation of sick SSI and MEunits so as to ensure smooth flow of credit to these sectors. The Reserve Bankhas also formulated a one-time settlement scheme for recovery of non-performingassets (NPAs) below Rs.10 crore for SME accounts and detailed guidelines havebeen issued to public sector banks for implementation. A debt restructuringmechanism for units in the SME sector, in line with the corporate debt restructuring(CDR) mechanism prevailing in the banking sector, has been formulated by theReserve Bank and guidelines were issued for implementation.

(d) Restructuringand Development of Regional Rural Banks

72. As indicated inthe annual policy Statement of April 2005, an Internal Group (Chairman: Shri A.V. Sardesai) was set up by the Reserve Bank to examine various alternativesavailable within the existing legal framework for strengthening regional ruralbanks (RRBs) and making them viable rural financial institutions. The Groupsubmitted its report in June 2005, which has been sent to the Government forcomments. The major recommendations of the Group include merger/amalgamation ofRRBs to improve operational viability, change of sponsor banks to enhancecompetitiveness, strengthening of balance sheets in respect of merged entities,regulatory and supervisory strengthening, governance and management and scopefor improving profitability.

(e) Micro-finance

73. The programme oflinking self-help groups (SHGs) with the banking system continues to be themajor micro-finance programme in the country and is being implemented bycommercial banks, RRBs and co-operative banks. By

end-July 2005, as many as 16,53,047 SHGs were linked to banks and the totalflow of credit to SHGs was Rs.7,063 crore.

74. The followingmeasures have been initiated to give further impetus to the micro-financeendeavour:

In pursuance ofthe Union Budget, 2005-06, the Micro Finance Development Fund (MFDF) set up inthe NABARD has been redesignated as the Micro Finance Development and EquityFund (MFDEF) and its corpus has increased from Rs.100 crore to Rs.200 crore.The modalities in regard to the functioning of the MFDEF are being worked out.

The Internal Group(Chairman: Shri H.R. Khan) constituted by the Reserve Bank to examine issuesrelating to rural credit and micro-finance submitted its report in July 2005which was placed on the Reserve Banks website for wider dissemination.Important recommendations of the Group include providing comprehensivefinancial services in rural areas encompassing savings, credit, remittance,insurance and pension products and establishing linkages between banks andexternal entities based on two broad models, viz., business facilitatormodel and business correspondent model. The Group has also suggested severalsteps to promote SHGs and micro-finance institutions (MFIs) which includefuture growth of SHG-Bank Linkage and MFI-Bank Linkage programmes, utilizationof MFDEF funds to facilitate formation of SHG federations for offering serviceslike rural housing loans, micro-insurance and tie-up with service providers,development of accounting standards for SHGs and NGOs, capacity building ofMFIs, rating of MFIs, development of rating models and training modules forMFIs. The recommendations of the Group are under examination.

(f) Revival ofRural Co-operative Banking Institutions and Long-term Co-operative CreditStructure

75. The Task Forceappointed by the Government (Chairman: Prof. A. Vaidyanathan) to propose anaction plan for reviving the rural co-operative banking institutions andsuggesting an appropriate regulatory framework for these institutions submittedits report in February 2005. The Government has accepted the recommendations ofthe Task Force, in principle, and held consultative meetings with the StateGovernments. The Government has entrusted the work of studying the long-termco-operative credit structure for agriculture and rural development to the TaskForce.

(g) SpecialRelief Measures by Banks in Areas Affected by Natural Calamities

76. The Reserve Bankhas issued guidelines/instructions to banks in regard to relief measures to beprovided in areas affected by natural calamities from time to time. Theseguidelines cover various relief measures pertaining to credit to existingborrowers, mainly in the agricultural sector. During recent calamities such as tsunami ,heavy rains, floods and earthquakes in some parts of the country, a number ofinstances relating to functioning of ATMs, opening of accounts of smallcustomers, operations of accounts in the absence of documents and failure ofcomputer networks have come to the notice of the Reserve Bank. Accordingly, itis proposed to constitute an internal Working Group to examine the whole gamutof issues and suggest suitable revisions to the existing guidelines, with aview to making them comprehensive.

IV. PrudentialMeasures

(a) CapitalMarket Exposure Limits: Rationalisation

77. As per thecurrent norms, a banks aggregate exposure in all forms to the capital marketshould not exceed five per cent of its total outstanding advances (includingcommercial paper) as on March 31 of the previous year. Within this overallceiling, the banks investment in shares, convertible bonds and debentures andunits of equity-oriented mutual funds should not exceed 20 per cent of its networth. On a consolidated basis, the banks aggregate exposure to capitalmarkets should not exceed two per cent of its total on-balance-sheet assets(excluding intangible assets and accumulated losses) as on March 31 of theprevious year. Within the total limit, investment in shares, convertible bondsand debentures and units of equity-oriented mutual funds should not exceed 10per cent of the banks consolidated net worth.

78. The Reserve Bankhas undertaken a review of the prudential limits on the capital market exposurewith a view to rationalising them in terms of base and coverage. Accordingly,it is proposed:

to restrict abanks aggregate capital market exposure to 40 per cent of the net worth of thebank on a solo and consolidated basis.

to modify a banksconsolidated direct capital market exposure to 20 per cent of the banksconsolidated net worth.

to simplify andrationalise the exemptions in regard to the coverage.

79. Banks exceedingthese limits either on solo or consolidated basis should approach the ReserveBank with a plan for bringing down the exposure within the permissible limits.Banks having sound internal controls and robust risk management systems canapproach the Reserve Bank for higher limits. Guidelines in this regard would beissued separately.

(b) PrudentialProvisioning Requirements: Review

80. In terms of theprudential guidelines, banks are required to assess their entire loans andadvances portfolio on an account-by-account basis with regard to the degree ofdelinquency and classify them into four broad asset classification categories, viz. standard, sub-standard, doubtful and loss. The standard assets attract auniform provisioning requirement of 0.25 per cent of the funded outstanding ona portfolio basis. Banks are required to make specific provisions in respect ofsub-standard assets at a uniform rate of 10 per cent of the funded outstandingand for doubtful accounts at rates ranging from 20 to 100 per cent, taking intoaccount the period for which the account has remained non-performing and therealisable value of security charged to the bank.

81. Traditionally,banks loans and advances portfolio is pro-cyclical and tends to grow faster duringan expansionary phase and grows slowly during a recessionary phase. Duringtimes of expansion and accelerated credit growth, there is a tendency tounderestimate the level of inherent risk and the converse holds good duringtimes of recession. This tendency is not effectively addressed by the abovementioned prudential specific provisioning requirements since they capture riskex post but not ex ante.

82. The variousoptions available for reducing the element of pro-cyclicality include, amongothers, adoption of objective methodologies for dynamic provisioningrequirements, as is being done by a few countries, by estimating therequirements over a business cycle rather than a year on the basis of theriskiness of the assets, establishment of a linkage between the prudentialcapital requirements and through-the-cycle ratings instead of point-in-timeratings and establishment of a flexible loan-to-value (LTV) ratio requirementswhere the LTV ratio would be directly related to the movement of asset values.

83. Taking intoaccount the recent trends in credit growth, it is proposed:

to increase thegeneral provisioning requirement for standard advances from the present levelof 0.25 per cent to 0.40 per cent. Banks direct advances to agricultural andSME sectors would be exempted from the additional provisioning requirement. Ashitherto, these provisions would be eligible for inclusion in Tier II capitalfor capital adequacy purposes up to the permitted extent. Operationalguidelines in this regard would be issued separately.

(c) New CapitalAdequacy Framework: Status

84. Draft guidelinesfor implementation of the New Capital Adequacy Framework have been formulatedand placed on the Reserve Banks website. In line with international standards,banks were advised to adopt the Standardised Approach for credit risk witheffect from March 31, 2007. Banks adopting the Standardised Approach would usethe rating assigned by only those credit rating agencies, which are identifiedby the Reserve Bank. Accordingly, an in-house Group has been constituted in theReserve Bank for identifying the external rating agencies. Final guidelineswould be issued on the basis of the recommendations of the Group and thefeedback received thereon.

85. Under the NewFramework, banks are required to adopt the Basic Indicator Approach (BIA) forcomputing capital requirement for operational risk. The Reserve Bank has issueda Guidance Note on Management of Operational Risk in

October 2005 to facilitate a smooth transition to the New Framework. Banksusing BIA are encouraged to comply with Sound Practices for the Management andSupervision of Operational Risk issued by the Basel Committee on BankingSupervision (BCBS) in February 2003.

86. The BCBS hasundertaken the Fifth Quantitative Impact Study (QIS-5) to assess the impact ofadoption of New Capital Adequacy Framework. Twelve banks identified toparticipate in the QIS-5 were advised to familiarise themselves with therequirements of QIS-5 for effective participation.

(d) Capital AdequacyRequirements

87. Banks which havemaintained regulatory capital of at least nine per cent of the risk weightedassets for both credit risk as well as market risk in respect of held fortrading (HFT) and available for sale (AFS) categories as on March 31, 2006would be permitted to treat the entire balance in the investment fluctuationreserve (IFR) as Tier I capital. Once the amount of IFR is so transferredtowards Tier I capital, a headroom for raising an equal amount of Tier IIcapital would become available to the eligible banks, up to half of which couldbe raised through issuance of subordinated debt.

88. In terms of theprudential guidelines on capital adequacy, banks are required to maintaincapital charge for market risk in respect of their trading book exposures(including derivatives) and securities included under the AFS category witheffect from March 31, 2005 and March 31, 2006, respectively. Furthermore, banksare required to migrate to the New Capital Adequacy Framework with effect fromMarch 31, 2007. These developments would result in additional capitalrequirements for banks. Internationally, banks raise capital through equityshares and instruments such as subordinated debt and preference shares whichare eligible for inclusion in Tier I/Tier II/Tier III capital. Banks in India,however, do not currently have such options available except for raising TierII capital through subordinated debt to a limited extent. The Reserve Bank isexamining various types of capital instruments that can be permitted under theNew Capital Adequacy Framework.

(e) CorporateDebt Restructuring Mechanism

89.As mentioned inthe annual policy Statement of April 2005, the performance of the corporatedebt restructuring (CDR) mechanism was reviewed and draft guidelines on CDRmechanism were placed on the Reserve Banks website in May 2005 for widerdissemination. The changes to the existing CDR scheme have been finalisedtaking into account the feedback received. Operational guidelines in thisregard would be issued separately.

(f) SupervisoryReview Process

90. Having regard tothe recent trends in the credit markets it is proposed:

to initiate asupervisory review process with select banks having significant exposure tosome sectors, namely, real estate, highly leveraged NBFCs, venture capitalfunds and capital markets, in order to ensure that effective risk mitigants andsound internal controls are in place for managing such exposures.

(g) Financing ofNBFCs

91. As indicated inthe annual policy Statement of April 2005, an Informal Working Group(Chairperson: Smt. Usha Thorat) was constituted to examine the issues involvedin financing of NBFCs by banks and suggest ways to use the core competencies ofNBFCs in extending credit to small borrowers. The recommendations of the Groupinclude: (i) extending bank finance to NBFCs for permissible activities; (ii)using NBFCs as business correspondents or agents; (iii) permitting banks torediscount the bills discounted by NBFCs pertaining to the transport sector; (iv)using NBFCs as a conduit for providing long-term funds to the SME sector; and(v) extending training facilities to NBFCs engaged in financing the SSI andagriculture sectors. The recommendations are under examination.

(h) CreditInformation Companies (Regulation) Act, 2005: Status

92. The CreditInformation Companies (Regulation) Act, 2005 was notified in the Gazette ofIndia on June 23, 2005 and the Government requested the Reserve Bank to framerules and regulations for implementation of the Act. Accordingly, a WorkingGroup (Chairman: Shri Prashant Saran) was constituted with representatives fromthe Reserve Bank, the IBA, the Credit Information Bureau of India Ltd. (CIBIL)and select banks. The Group, in consultation with the Ministry of Law, preparedthe draft rules and regulations for implementation of the Act with specificprovisions for protecting individual borrowers rights and obligations. Thedraft rules and regulations are being examined by the Reserve Bank.

(i) Setting up ofBanking Codes and Standards Board of India: Status

93. Modalitiesregarding setting up of an independent Banking Codes and Standards Board ofIndia (BCSBI) on the model of the mechanism in the UK are being worked out inpursuance of the annual policy Statement of April 2005 in order to ensure thata comprehensive code of conduct for fair treatment of customers is established.

(j) FinancialInclusion

94. The annualpolicy Statement of April 2005, while recognizing the concerns in regard to thebanking practices that tend to exclude rather than attract vast sections ofpopulation, urged banks to review their existing practices to align them withthe objective of financial inclusion. In many banks, the requirement of minimumbalance and charges levied, although accompanied by a number of freefacilities, deter a sizeable section of population from opening/maintainingbank accounts. With a view to achieving greater financial inclusion, all banksneed to make available a basic banking no frills account either with nil orvery low minimum balances as well as charges that would make such accountsaccessible to vast sections of population. The nature and number oftransactions in such accounts could be restricted, but made known to thecustomer in advance in a transparent manner. All banks are urged to give widepublicity to the facility of such a no-frills account so as to ensure greaterfinancial inclusion.

(k) Issue ofCo-branded Debit Cards by Banks

95. At present,banks are required to obtain the Reserve Banks approval for issue of debitcards in tie-up with other non-bank entities for marketing and distributionpurposes. In order to further liberalise the procedure, it is proposed:

to accord generalpermission to banks to issue debit cards in tie-up with non-bank entities subjectto certain conditions. Detailed instructions would be issued separately.

(l) Anti-MoneyLaundering Guidelines: Status

96. In recent years,prevention of money laundering has assumed importance in internationalfinancial relationships. In this context, in November, 2004 the Reserve Bankrevised the guidelines on Know Your Customer (KYC) principles in line withthe recommendations made by the Financial Action Task Force (FATF) on standardsfor Anti-Money Laundering (AML) and Combating Financing of Terrorism (CFT).Banks were advised to frame their KYC policies with the approval of theirboards and ensure that they are compliant with its provisions by December 31,2005. The salient features of the policy relate to the procedure prescribed inregard to customer acceptance, customer identification, risk management andmonitoring of transactions. The revised guidelines envisage verification of theidentity and address of the customer through independent source documents asmandatory and banks are required to classify the accounts according to theirrisk perceptions. In order to ensure that the inability of persons belonging tolow income groups to produce documents to establish their identity and addressdoes not lead to their financial exclusion and denial of banking services, asimplified procedure has been provided for opening of account in respect ofthose persons who do not intend to keep balances above Rs.50,000 and whosetotal credit in one year is not expected to exceed Rs.1,00,000.

V. Institutional Developments

Payment andSettlement Systems

(a) ElectronicPayment Products: Status and Proposed Action

97. The coverage ofReal Time Gross Settlement (RTGS) system has increased significantly. As onOctober 19, 2005 RTGS connectivity was available in 11,280 bank branches at 508cities. By end-March 2006, 15,000 branches are proposed to be covered and thenumber of monthly transactions of the system is expected to expand from onelakh to two lakh.

98. The NationalElectronic Funds Transfer (NEFT) system for electronic transfer of funds wouldbe implemented in phases for all networked branches of banks all over thecountry. By end-December 2005, NEFT would be operationalised in 34 banks. Byend-June 2006, the remaining banks are expected to be part of the system.Currently, the package for operationalisation of NEFT is being tested forimplementation.

99. The pilotproject for Cheque Truncation System, which aims at enhancing efficiency in theretail cheque clearing sector, is expected to be implemented in New Delhi byend-March 2006.