Indian Economy & Indian Financial System
RBI Guidelines & Basel Norms
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RBI Guidelines & Basel Norms
Introduction
RBI guidelines and Basel norms form the regulatory backbone of the Indian banking system. This topic covers the Narasimham Committee reforms, prudential norms, capital adequacy requirements, supervisory frameworks, and Basel standards. For JAIIB candidates, understanding these regulatory requirements is essential as they directly impact bank operations, risk management, and compliance.
Banking Sector Reforms
Narasimham Committee I (February 1992)
The Committee on Financial System (CFS) was chaired by M. Narasimham, appointed by the Government of India to rebuild the financial health of commercial banks and make their functioning efficient and profitable.
Based on the committee's recommendations, RBI issued fresh guidelines on Income Recognition, Asset Classification, and Provisioning in February 1992.
Key Recommendations
| Recommendation | Details |
|---|---|
| 4-tier banking structure | 3-4 large banks (including SBI) at top; rural banks at bottom |
| Supervisory body | Quasi-autonomous body under RBI for supervision |
| SLR reduction | Phased reduction of Statutory Liquidity Ratio |
| Capital adequacy | Phased achievement of 8% CAR |
| Branch licensing | Abolition of branch licensing policy |
| Asset classification | Proper classification with full disclosure |
| Interest rate deregulation | Market-determined interest rates |
| Asset Reconstruction Fund | To take over stressed loan portfolios |
Reforms Implemented (1992)
- Capital adequacy norms: RBI fixed CAR at 8% in April 1992; all PSBs achieved it by March 1996
- Progressive reduction of CRR and SLR: High SLR and CRR had reduced bank profits; reduction increased loanable funds
- Prudential norms: Introduced to impart professionalism
- Deregulation of interest rates: Freed in stages for both deposits and advances (since 1992)
- Debt Recovery Tribunal: "Recovery of Debts due to Banks and Financial Institutions Act, 1993" — six Special DRTs set up
- New private sector banks licensed and permitted to operate
- Mergers and amalgamation promoted
Narasimham Committee II (1998)
Committee on Banking Sector Reforms — to review progress and chart further reforms for international competitiveness.
Key Recommendations
| Recommendation | Details |
|---|---|
| Strengthening banks | Handle domestic liquidity and exchange rate management under convertibility |
| Merger of strong banks | "Multiplier effect" on the industry |
| Narrow Banking | For banks with NPAs as high as 20% of assets — invest only in short-term, low-risk assets |
| Capital Adequacy | Raise minimum CAR to 9% to improve loss absorption |
| Bank ownership | Government control and bank autonomy don't coexist — review Board functioning |
| Banking laws review | Urgent need to amend RBI Act, BR Act, SBI Act, Bank Nationalisation Act |
Benefits of Second Phase Reforms
- Deregulation of branch licensing
- Prudential norms and disclosure requirements
- Enhanced capital adequacy
Prudential Reforms
Prudential reforms include phased implementation of international best practices to lower overall risk:
Focus Areas
- NPAs — Non-Performing Assets management
- Capital adequacy — maintaining sufficient capital buffers
- Diversification of operations — spreading risk
Specific Measures
- Risk-weighted Capital Adequacy Ratio (CAR)
- Appropriate accounting norms
- Recognition of different components of risk
- Risk-weight assignment to various asset classes
- Marked-to-market principle for investment portfolio
- Limits on fund deployment in sensitive activities
- Migration to advanced methods
- Graded approach to bank licensing announced in Union Budget 2014 — creation of differentiated banks
Supervisory Reforms
| Reform | Description |
|---|---|
| Board for Financial Supervision | Apex supervisory authority for commercial banks, FIs, and NBFCs |
| CAMELS rating system | Capital adequacy, Asset quality, Management, Earnings, Liquidity, Systems |
| Risk-based supervision | Transition from compliance-based to risk-focused oversight |
| Consolidated supervision | Of financial conglomerates |
| Statutory auditors | Recasting their role for enhanced assurance |
| Internal audit | Strengthened for improved internal control |
| Corporate governance | Enhanced due diligence on important shareholders; fit and proper tests for directors |
Basel Norms
Capital Adequacy Requirements
| Standard | Minimum CAR |
|---|---|
| Narasimham I (1992) | 8% |
| Narasimham II (1998) | 9% |
| Basel III | Continuous compliance required |
Foreign Bank Requirements
Foreign banks must comply with:
- Minimum paid-up capital of Rs. 500 crore (by remittance from parent bank)
- Basel III requirements on a continuous basis
- Minimum CRAR not less than 10% for initial three years
- Can raise non-equity rupee resources like domestic banks
- Core management functions cannot be outsourced (including to group entities)
Credit Rating Agencies (CRAs) for Basel Risk-Weighting
Seven SEBI-approved CRAs in India (also accredited by RBI for risk-weighting claims):
- CRISIL Ratings Limited
- India Ratings and Research (formerly Fitch India)
- ICRA Limited
- CARE Ratings Ltd.
- Brickwork Ratings India Pvt. Ltd.
- Infomerics Valuation and Rating Pvt. Ltd.
- Acuite Ratings & Research Limited
All 7 CRAs have been accredited by RBI for capital adequacy risk-weighting purposes.
ECLGS and CGTMSE (COVID-era Guidelines)
Emergency Credit Line Guarantee Scheme (ECLGS)
- Rs. 3 lakh crore collateral-free credit scheme during COVID
- Intended to benefit 45 lakh MSMEs
- Incentivises Member Lending Institutes (MLIs) to provide extra credit at reasonable interest rates
Credit Guarantee Fund Trust for MSEs (CGTMSE)
- Collateral-free loans up to Rs. 1 crore for individual MSEs
- Joint initiative of Ministry of MSME and SIDBI
- Supported pandemic-affected MSMEs in recovery
Market Reforms
Key market reforms under RBI guidelines:
- Removal of administered interest rates
- Reduction of CRR and SLR from high levels
- Discontinuation of ad hoc treasury bills
- Market-determined pricing for government securities
- Pure inter-bank call money market
- Auction-based repos/reverse repos for short-term liquidity management
- Improved payment and settlement mechanisms
Institutional Reforms
| Institution/Mechanism | Purpose |
|---|---|
| Credit Information Bureau | Information exchange on defaulters and borrowers |
| CCIL | Central counterparty for fixed income and money market settlement |
| Lok Adalats | Quick dispute resolution |
| Debt Recovery Tribunals | Faster recovery of banking dues |
| Asset Reconstruction Companies | Take over stressed assets |
| SARFAESI Act | Protect creditors' interests |
| IBC, 2016 | Insolvency and Bankruptcy Code |
Key Points to Remember
- Narasimham Committee I (1992): 4-tier banking structure, 8% CAR, deregulated interest rates, DRTs
- Narasimham Committee II (1998): 9% CAR, narrow banking, merger of strong banks
- CAMELS: Capital adequacy, Asset quality, Management, Earnings, Liquidity, Systems
- Board for Financial Supervision: Apex supervisor for banks, FIs, and NBFCs
- 7 SEBI-approved CRAs in India, all RBI-accredited for risk weighting
- Foreign banks: minimum Rs. 500 crore capital, Basel III compliance, CRAR minimum 10% for first 3 years
- ECLGS: Rs. 3 lakh crore collateral-free for 45 lakh MSMEs (COVID response)
- CGTMSE: Collateral-free loans up to Rs. 1 crore for MSEs (Ministry of MSME + SIDBI)
- Key 1992 reforms: Capital adequacy, CRR/SLR reduction, lending rate deregulation, DRTs, new private banks
- Interest rates freed in stages since 1992 for both deposits and advances
- Risk-based supervision replaced compliance-based approach
- Graded approach to bank licensing (Union Budget 2014) — differentiated banks concept
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