Module 5: Financial Sector Reforms in India

Need for Reforms: The role of the financial system in India, until the early
1990s, was primarily restricted to the function of channelling resources from
the surplus to deficit sectors.
• Whereas the financial system performed this role reasonably well, its
operations came to be marked by some serious deficiencies over the
years.
• The banking sector suffered from lack of competition, low capital base,
low productivity and high intermediation cost.
• After the nationalization of large banks in 1969 and 1980, public
ownership dominated the banking sector.
• The role of technology was minimal and the quality of service was not
given adequate importance.
• Banks also did not follow proper risk management system and the
prudential standards were weak.
• All these resulted in poor asset quality and low profitability.
• Among non-banking financial intermediaries, development finance
institutions (DFIs) operated in an over-protected environment with most
of the funding coming from assured sources at concessional terms.
• In the insurance sector, there was little competition.
• The mutual fund industry also suffered from lack of competition and was
dominated for long by one institution, viz., the Unit Trust of India.
• Non-banking Financial Companies (NBFCs) grew rapidly, but there was
no regulation of their asset side.
• Financial markets were characterized by control over pricing of financial
assets, barriers to entry, high transaction costs and restrictions on
movement of funds/participants between the market segments.
• Apart from inhibiting the development of the markets, this also affected
their efficiency.
• Financial Sector Reforms: A General Perspective: Against this backdrop,
wide-ranging financial sector reforms in India were introduced as an
integral part of the economic reforms initiated in the early 1990s.
• The principal objective of financial sector reforms was to improve the
allocative efficiency of resources and accelerate the growth process of
the real sector by removing structural deficiencies affecting the
performance of financial institutions and financial markets.
• The main thrust of reforms in the financial sector was on the creation of
efficient and stable financial institutions and markets.
• Reforms in respect of the banking as well as non-banking financial
institutions focused on creating a deregulated environment and enabling
 free play of market forces while at the same time strengthening the
prudential norms and the supervisory system.
• In the banking sector, the focus was on imparting operational flexibility
and functional autonomy with a view to enhancing efficiency,
productivity and profitability, imparting strength to the system and
ensuring accountability and financial soundness.
• The restrictions on activities undertaken by the then existing institutions
were gradually relaxed and barriers to entry in the banking sector were
removed.
• Reforms in the commercial banking sector had two distinct phases.
• The first phase of reforms, introduced subsequent to the release of the
Report of the Committee on Financial System, 1992 (Chairman: Shri M.
Narasimham), focused mainly on enabling and strengthening measures.
• The second phase of reforms, introduced subsequent to the
recommendations of the Committee on Banking Sector Reforms, 1998
(Chairman: Shri M. Narasimham) placed greater emphasis on structural
measures and improvement in standards of disclosure and levels of
transparency in order to align the Indian standards with international
best practices.
• In the case of non-banking financial intermediaries, reforms focused on
removing sector-specific deficiencies.
• Thus, while reforms in respect of DFIs focused on imparting market
orientation to their operations by withdrawing assured sources of funds,
in the case of NBFCs, the reform measures brought their asset side also
under the regulation of the Reserve Bank.
• In the case of the insurance sector and mutual funds, reforms attempted
to create a competitive environment by allowing private sector
participation.
• Reforms in financial markets focused on removal of structural
bottlenecks, introduction of new players/instruments, free pricing of
financial assets, relaxation of quantitative restrictions improvement in
trading, clearing and settlement practices, more transparency, etc.
• Reforms encompassed regulatory and legal changes, building of
institutional infrastructure, refinement of market microstructure and
technological up gradation.
• In the various financial market segments, reforms aimed at creating
liquidity and depth and an efficient price discovery process.
• India weathered the disruptions in the global financial system mainly
due to a robust regulatory and supervisory framework, limited openness
 and global exposure of banking system with timely policy actions
especially to manage liquidity.
• It was, however, acknowledged that financial sector reforms would have
to keep progressing with continued improvements in regulation,
supervision and stability areas in order to avoid build up of new
vulnerabilities.
• The global financial crisis provided a renewed impetus to the second
generation financial sector reforms in India whose major components
were identified as:
• (i) Adherence to international standards, especially implementing G20
commitments;
• (ii) Developmental measures; and
• (iii) Stability measures.
• Against the backdrop of a felt need that the legal and institutional
structure of the Financial sector in India need to be reviewed and recast
in tune with the contemporary requirements of the sector, The Financial
Sector Legislative Reforms Commission (FSLRC), headed by Justice B.N.
Srikrishna, was set up by Ministry of Finance in March 2011 to review,
simplify and rewrite the legal and institutional structures of the financial
sector.
• The FSLRC presented its Report to the Finance Minister in March, 2013.
• The Commission looked at two important aspects of the Financial
Sector- the numerous laws governing the financial sector and the
multiple regulatory setups across the sector.
• Among the most important of the recommended changes by FSLRC are:
• (i) The decision to merge the roles of the Securities and Exchange Board
of India, the Forward Markets Commission, Insurance Regulatory and
Development Authority, and Pension Fund Regulatory and Development
Authority into a single regulator called the “Unified Financial Agency”
(UFA), on the grounds that all financial activity other than banking and
the payments system, which would continue to be regulated by the
Reserve Bank of India (RBI), should be brought under a single authority.
• (ii) The continuation of the Financial Stability Development Council
(FSDC) with the mandate to monitor and address systemic risk, which is
to be led by the finance ministry.
• (iii) The creation of a Resolution Corporation that would identify
institutions that are threatened by insolvency and resolve the problem
at an early stage.
• (iv) The creation of a Public Debt Management Agency that would take
the responsibility of public debt Management away from the RBI.
Indian Financial Sector: The Big Picture:
• Banks dominate the Indian financial system.
• This is reflected from the following table containing financial system
share by asset size.

Segment Market Share of

Financial Assets
(percentage)

Banks … 63
Insurance Companies 19
Non-Banking Financial 8
Institutions
Mutual Funds …. 6
Provident and Pension 4
Funds
Total 100

• The banking system is dominated by commercial banks.

• This is reflected from the following table containing banking system
share by asset size.

Institution Market Share of Total

Banking Assets
(percentage)
Scheduled Commercial 92.4
Banks
Public Sector Banks 67.2
Private Sector Banks …. 18.7
Foreign Banks 6.5
Regional Rural Banks 2.7
Rural and Urban 3.4
Cooperative Banks
Local Area Banks 1.5
Total 100
• Public sector banks have more branch presence relative to their share of
assets.
• This is reflected from the following table.

Type of Number Number Percentage Market

Banks of Banks of Share of Share of
Branches Number of Assets
Branches (percentage)

Public 26 67466 83 72.8

Sector
Private 20 13452 16.6 20.2
Sector
Foreign 41 323 0.4 7
Banks
Total 87 81241 100 100

• The data presented above reveal the following:

• Within the banking system, public sector banks (PSB) continue to
dominate with 73 per cent of market share of assets and 83 per cent of
branches.
• Rural and urban cooperative banks have a relatively small share in the
banking system. However, given their geographic and demographic
outreach, they play a key role in providing access to financial services to
low and middle income households in both rural and urban areas.
• Similarly, RRBs play a key role in promoting financial inclusion. The
Government is pursuing branch expansion and capital infusion plans for
the RRBs.
• Major Banking Sector Reforms Since 1991: Following are the major
reforms aimed at improving efficiency, productivity and profitability of
banks.
• New banks licenced in private sector to inject competition in the system.
10 in 1993 and 2 more in 2003.
• FDI+FII up to 74 per cent allowed in private sector banks.
• Listing of public sector banks on stock exchanges and allowing them to
access capital markets for augmenting their equity, subject to
 maintaining government shareholding at a minimum of 51 per cent.
Private shareholders represented on the board of public sector banks.
• Progressive reduction in statutory pre-emption (SLR and CRR) from their
highest levels in 1991 to improve the resource base of banks so as to
expand credit available to private sector.
• Adoption of international best practices in banking regulation.
Introduction of prudential norms on capital adequacy, Income
Recognition and Asset Classification (IRAC) provisioning, exposure
norms, etc.
• Phased liberalisation of branch licensing. Banks can now open branches
in Tier 2 to Tier 6 centres without prior approval from the Reserve Bank.
• Deregulation of a complex structure of deposit and lending interest rates
to strengthen competitive impulses, improve allocative efficiency and
strengthen the transmission of monetary policy.
• Base rate (floor rate for lending) introduced in July 2010. Prescription of
an interest rate floor on savings deposit rate withdrawn in October
2011.
• Functional autonomy to public sector banks.
• Use of information technology to improve the efficiency and
productivity, enhance the payment and settlement systems and deepen
financial inclusion.
• Strengthening of Know Your Customer (KYC) and Anti-Money Laundering
(AML) norms; making banking less prone to financial abuse.
• Improvements in the risk management culture of banks.
• Entry of banks into insurance sector allowed.
• Credit Guarantee Fund Schemes for education loan and that for skill
development launched.
Major issues in Banking Sector Reforms: After the global financial crisis and
the recent episodes of EU debt crisis, all major economies of the world have
started the second phase of reforms in banking and other areas.
• This bears an impact on the Indian economy and raises some issues also,
which deserve special attention.

Issue 1: Public vs Private Ownership of Banks: Both public and private

banks have respective advantages and disadvantages.
• Private ownership brings competition, professionalism and operational
efficiency. Public ownership makes it easier to pursue social objectives
such as mass banking, financial inclusion, etc.
• Private banks have comparatively greater freedom in terms of
recruitment, salary and compensation. On the other hand, PSBs are
 perceived to offer more job security, and consequently, employee
turnover is lower.
• PSBs dominate the banking sector in India and will continue to do so in
foreseeable future. However, these banks require substantial capital to
support growth.
• In 2013, under certain assumptions, RBI has made an estimate of the
additional capital requirements of domestic banks for full Basel III
implementation till March 2018.
• According to this estimate, out of Rs.4.95 trillion additional capital
requirement, public sector banks will require Rs.4.15 trillion.
• Over last seven years, the Government has infused over Rs.550 billion in
PSBs at the current shareholding ranging between 55 per cent to 82 per
cent.
• The critical question is whether the government, given its limited fiscal
space, can meet the enhanced capital needs of PSBs under the Basel III
capital regulations.
• Moreover, how should the government enforce its rights and obligations
as the owner of PSBs? Through the board, or through other means of
interaction?
• Should the government think of diluting its shareholding in PSBs given its
fiscal constraints?
• In fact, there is a need for a debate on the ideal capital structure of PSBs
such that they can best serve the demands of inclusive growth of the
economy.

Issue 2: Consolidation of Banks: Consolidation of banks assumed

significance after the introduction of financial sector reforms starting in
the early 1990s.
• It gained momentum after the Narasimham Committee-I (1992) put
forward the broad pattern of the banking sector (3 or 4 large banks, 8 to
10 national banks, local banks and rural banks).
• This was further reiterated by S.H. Khan Committee (1997), Narasimham
Committee-II (1998), Raghuram Rajan Committee (2009), Committee on
Financial Sector Assessment (2009) and Committee on Fuller Capital
Account Convertability (2006).
• All committees viewed that restructuring of the banking system should
be market-driven based on viability and profitability considerations and
brought about through a proces of Mergers and Amalgamations.
• Since the first round of nationalisation of banks in 1969, there have been
a total of 41 mergers and amalgamations. Of these, 17 happened before
the onset of the reforms in 1991 and 24 after that.
• Arguments given in support of consolidation of banks are:
• Higher capital base after consolidation will facilitate increased lending
activity and faster GDP growth.
• Boost infrastructure financing from the perspective of enhanced
exposure limits for single and group borrowers.
• Meet the banking service demands of Indian corporates, both at home
and globally.
• Cost benefits for banks due to economies of scale and economies of
scope such as centralised back office processing, elimination of branch
overlap and duplication of administrative infrastructure, better
manpower planning, optimum funds management, consolidation of
operations, savings in it and other purchases.
• Consolidation will efford focused supervision.
• Larger size means wider and richer experience in financial inclusion.
• International acceptance and recognition.
• Better risk management.
• Arguments against consolidation of banks are:
• Lead to complexity and adverse impact on financial stability.
• Regulatory issues: significant big sized banks could resort to
monopolistic practices that may result in unequal competition and
distortive and even predatory behaviour in the market. Such practices
could also adversely affect the monetary transmission and market
mechanism for efficient allocation of resources.
• It could also pose problems such as technology migration issues,
customer attrition, implementation costs, HR issues (Viz., seniority,
salary, transfers, promotions, parity in perks, etc.) and litigation, will not
be able to provide personalised services provided by small banks.
• Presently, significant skewness exists in the size of banks. This creates a
monopolistic situation.
• The task is to ensure that there are at least four or five banks of
comparable size at all times to ensure that consolidated banks do not
acquire monopolistic market power and adopt predatory behaviour.
• It is rather necessary to ensure that if consolidation in the banking sector
is applied, it paves the way for stronger financial institutions with the
capacity to meet the corporate and infrastructure funding needs and
those of the global economy.
• Issue 3: Large and Small Banks: An issue related to the debate on
consolidation in banking sector is the ongoing debate on whether we
need small number of large banks or large number of small banks to
promote financial inclusion.
• Small local banks with geographical limitations play an important role in
the supply of credit to small enterprises and agriculture.
• While small banks have the potential for financial inclusion, performance
of these banks in India (LABs and UCBs) has not been satisfactory.
• If large banks are to be preferred, the issues related to their size,
numbers, capital requirements, exposure norms, regulatory
prescriptions and corporate governance need to be suitably addressed.
• Large bank may be large in terms of large asset size or large in terms of
global footprints.
• In India, the issue is to build up a large bank whose presence is globally
recognised.
• Similarly, merely encouraging small banks without addressing the
disadvantages of being small will not serve the purpose.
• Small banks are prone to fail frequently and we have to develop the
political and financial resilience to accept failures of small banks.
• There is a need for a faster and more effective framework for resolution
and settlement of deposit insurance claims in the event of failure of a
bank.
• When small banks become successful, they naturally want to expand
and grow. Should we allow a smooth transition from small to big? But if
we do that, aren’t we defeating the very rationale of such banks, i.e.,
that they will be nimble and flexible and meet local demands?
Merits and Demerits of Large Banks
Following arguments are given in support of large banks:
• Large banks can exploit economies of scale and scope leading to
economic efficiency.
• Large banks will have the capacity, resilience and the innovative zeal to
pursue financial inclusion. They will bring diverse experiences to bear on
local initiatives.
• Large banks can potentially become significant global players and
thereby give a global reach to Indian corporates.
• Large banks with huge capital base can better meet the huge funding
requirements of the infrastructure sectors.
Arguments against large banks are:
• Large banks can become too-big-to fail, leading to moral hazard
problems.
• Proliferation of non-core activities, either in the books of the bank or
through off-balance sheet vehicles such as investment banking,
securitisation, derivatives trading, etc. could pose significant systemic
risk because of their complexity and opacity.
• Large banks may indulge in monopolistic practices thereby suppressing
competing institutions and markets.
• Large banks may dilute the benefits of competition.
Merits and Demerits of Small Banks:
Arguments in support of small banks are:
• Small banks have a comparative advantage in the supply of credit to
small business units, small farmers and other unorganised entities,
thereby furthering the cause of financial inclusion.
• Small local banks are more nimble and flexible. They can effectively
cater to unbanked areas and meet localised needs, thus again improving
and strengthening efficiency in financial inclusion.
• Small banks with limited area of operation would require less
infrastructure, staff and hence the operational expenses would be low.
• Failure of a small bank will not have any systemic impact and resolution
will be easier.
Arguments against small banks are:
• Small banks are potentially vulnerable to sector concentration risk.
• Small banks are vulnerable to geographic concentration risk from the
local economy and hence require higher level of CRAR.
• Small banks are not big enough to finance big investments including
infrastructure.
• Small banks are prone to local influence capture.
• A large number of small banks put pressure on the supervisory resources
of the central bank.
• Issue 4: Licensing Policy: India follows a universal bank licensing regime.
• With regard to domestic private sector banks, pursuant to the
recommendations of the Narasimham Committee-I (1992) and II (1998),
RBI issued guidelines to grant licences to new domestic private banks in
1993 and 2001 respectively with capital requirement of Rs.1 billion in
1993 and Rs.3 billion in 2001.
• Following these guidelines, 10 new private banks and later 2 more new
banks were granted bank licenses.
• In February 2013, fresh guidelines for licensing of new banks were
issued, inter alia permitting business/industrial houses to promote banks
with a capital requirement of Rs.5 billion.
• So far as foreign banks, at present, foreign banks operate in India as
branches of the parent bank. Currently, permission for opening of
branches by foreign banks in India is guided by India’s commitment to
WTO to allow 12 new branches in a year.
• Development financial institutions (DFIs) do not require a banking
licence. They are very marginal players in the financial sector.
• DFIs were given the option to convert into a bank and the guidelines for
the same were also issued in 2001, but no progress was seen further in
this regard.
• Should the universal banking be continued? Or, should we move to
differentiated banking regime?
• In October 2007, the Reserve Bank prepared a discussion paper on
Differentiated Bank Licensing.
• It said that the case for differentiated licensing will be reviewed after a
certain degree of success in the sense that financial inclusion is achieved
and the Reserve Bank is satisfied with the quality and robustness of the
risk management systems of the entire banking sector.
• Now the question arises: is it the time to review this issue of
differentiated licensing?
• In other words, should differentiated licensing be allowed for various
banking activities (retail, wholesale, trading in securities, mortgage
lending, infrastructure financing, micro lending, etc.) with differentiated
regulatory requirements depending upon the risks involved?
• Merits and Demerits of Differentiated Licensing:
Arguments in support of differentiated licensing are:
• Specialised entities have expertise in risk assessment and structuring of
infrastructure finance.
• Core competency could be better harnessed leading to enhanced
productivity in terms of reduced intermediation cost, better price
discovery and improved allocative efficiency.
• With differentiated licenses, we can get around issues of conflict of
interest that arise when a bank performs multiple functions.
• Customised application of supervisory resources according to the
banking type could result in optimisation of scarce resources.
Arguments against differentiated licensing are:
• Given the extent of financial exclusion in India, is it advisable to create a
regime where some banks are freed of the obligation of financial
inclusion?
• A universal bank would be able to cross subsidise across sectors to
optimise utilisation of resources and ensure better profitability of banks.
• Will specialised banks be prone to concentration risk because of
narrower business models?
• Issue 5: Investment Banking: Post sub-prime crisis, the US investment
banking sector collapsed due to high leverage and severe maturity
mismatches.
• Soon after, leading investment banks such as Morgan Stanley and
Goldman Sachs converted themselves into bank holding companies.
• The term ‘investment bank’ is not legally defined in India and no entities
are registered as such with SEBI.
• “Investment Banking” is commonly used to define entities that are into
asset management, capital raising, trading in securities, portfolio
management, merchant banking, underwriting, broking and those
offering business and financial advisory services.
• Pure investment entities, which do not have presence in the lending or
banking business, are regulated primarily by the capital market regulator
SEBI.
• Banks are subject to regulatory restrictions on their investments.
• Pure investment banks have a comparative advantage in corporate
structuring and raising capital from the market.
• As Indian corporate goes global, do we need pure investment banks in
India to serve their sophisticated financial needs and advisory services?
• Will exclusive investment banks militate against development goals such
as priority sector lending and financial inclusion?
• Is investment banking under the proposed Non-Operative Financial
Holding Company (NOFHC) a possible option?
• Need for more extensive debate on pros and cons of exclusive
investment banks in India.
• Issue 6: Financial Sector Legislative Reforms Commission (FSLRC): One of
the major causes of 2008 financial crisis was that credit intermediation
activities were conducted by non-banks (so-called shadow banks) which
were primarily outside the regulatory perview. This raised serious
concerns about regulatory arbitrage, requirements for similar regulation
of entities performing similar activities and issues of commonality of
risks and synergies of unified regulation for such entities.
• There exist strong interlinkages between banks and NBFCs and,
therefore, it is argued that unified regulation of these by the same
regulator is essential for financial stability.
• However, for monetary policy to be effective, credit creation (i.e., by
banks and credit institutions like NBFCs) should be regulated by the
central bank.
• Issue 7: Subsidiarisation of Foreign Banks: At present, foreign banks in
India operate as branches of the parent banks.
• Post crisis lessons support domestic incorporation of foreign banks, i.e.,
subsidiarisation.
• Main advantages of local incorporation are:
• Capital remains within the host country;
• Easier to define laws of which jurisdiction apply;
• Better corporate governance, local board of directors;
• Effective control in a banking crisis and enables host country authorities
to act more independently as against branch operations; and
• Regulatory comfort.
• Potential down side risk could be domination of the domestic financial
system by Wholly Owned Subsidiaries (WOS) of foreign banks.
• There were certain taxation and other issues which needed to be
resolved in consultation with the Government of India.
• The Income Tax Act has since been amended to exempt foreign bank
from payment of capital gains tax on subsidiarisation.
• The Banking Laws (Amendment) Bill, 2012 amended the Indian Stamp
Act, 1899 whereby conversion of branches of a foreign bank into WOS as
per the scheme or guidelines of RBI shall not be liable to duty under the
Indian Stamp Act, 1899 or any other law for the time being in force.
• Apart from taxation issues, there are a few other important issues in
conversion of foreign bank branches into wholly owned subsidiaries,
mainly of a legal nature, like transfer of rights and liabilities, finality of
transfer, etc. which need to be addressed.
• Introduction to Insurance Sector in India: The insurance business today,
is one of the most potential financial sectors with the global insurance
industry valued at approximately $2.5 trillion servicing both life and non-
life markets.
• By life Insurance, it protects the human assets of the economy and by
general insurance (also called non-life insurance or casualty and
property liability insurance), it protects capital assets.
• At the end of September 2013, there are 52 insurance companies
operating in India; of which 24 are in the life insurance business and 27
are in non-life insurance business.
• Of the 52 companies presently in operation, 8 are in the public sector
and 44 are in the private sector.
• On the basis of total premium income, LIC dominates the market with a
share of 72.70 per cent in 2012-13, leaving 27.30 per cent share of
market for private insurers.
• LIC also attracts about 93.46 per cent of the total investment in
insurance sector, leaving only 6.54 per cent for private insurers.
Background:
• The first life insurance company (Oriental Life Insurance
Company) in India was established in the year 1818.
• The first general insurance company (The Triton Insurance Company
Ltd.) in India was established in the year 1850.
• Insurance Act, 1938 was a time tested legislation, which has addressed
many important issues concerning the insurance business in India.
• 245 life insurers were nationalised in the year 1956 to set up “Life
Insurance Corporation of India”.
• 107 general (non-life) insurers were nationalised in the year 1972 to set
up “General Insurance Corporation of India” and its four subsidiaries.
• Nationalisation of insurance was opted on account of malpractices then
prevailing and inability of some of the insurers to duly manage the policy
holders’ funds and also to spread the message of life and general
insurance all over the country and to serve the needs of the economy in
the best interest of the people.
Need for Insurance Sector Reforms in India:
• The genesis of the insurance sector reforms can be traced to the adverse
economic condition prevailing in India when the Reserve Bank of India
had to mortgage gold abroad to borrow funds to finance imports of
essential commodities and due to almost bankruptcy of foreign
exchange reserves.
• Businesses were tightly regulated, and concentrated in the hands of a
few public sector insurers, thus creating lack of competition.
• There was less choice of insurance products, thus the sector was unable
to mobilise enough savings.
Insurance Sector Reforms in India:
• As a part of financial sector reforms, the government of India appointed
an Insurance Sector Reforms Committee in 1993 under the chairmanship
of R.N. Malhotra to evaluate the Indian insurance sector and
recommend the future directives for its improvement.
• The reforms aimed at creating an efficient and competitive financial
system to fulfill the requirements of the Indian economy to develop and
popularise the insurance business in the country.
• The Malhotra committee submitted its report in 1994, and some of the
key recommendations were as follows:
• 1. Government stakes in life insurance and general insurance companies
to be brought down to 50 per cent and 35 per cent respectively.
• 2. Government should take over the holdings of GIC and its subsidiaries,
and all the insurance companies should be given greater freedom to
operate insurance business in India.
• 3. A minimum paid up capital of Rs.1 billion should be required from a
new private company to enter into the Indian insurance sector.
• 4. No company should be allowed to deal in both life and general
insurance in the name of a single entity.
• 5. Foreign companies can only be allowed to enter the insurance
industry in collaboration with the Indian companies.
• 6. Postal life insurance should be permitted to operate in rural India.
• 7. Computerisation of operations and updated technology are to be
initiated in the insurance sector to bring in speed and accuracy.
• 8. An insurance regulatory body should be set up to maintain and
regulate insurance business in India.
• 9. ‘Controller of Insurance’ should be transformed into an independent
authority.
• 10. LIC should pay interest on delays and payments beyond 30 days and
insurance companies must be encouraged to set up unit-linked
insurance and pension plans.
• These and other recommendations of the Malhotra committee could,
however, be implemented only in the late 1990s with the establishment
of Insurance Regulatory and Development Authority (IRDA) in 2000
under IRDA Act, 1999.
• It should also be noted here that another committee (called Mukherjee
Committee) was set up by the government in 1995 and the committee
submitted its report in 1997, but the report was not made public.
• In 1996, the government set up an interim Insurance Regulatory
Authority (IRA).
• In 1997, the government gave greater autonomy to LIC, GIC and its
subsidiaries with regard to the restructuring of boards and flexibility in
investment norms aimed at channelling funds to the infrastructure
sector.
• In 1998, it was decided by the cabinet to allow 40 per cent foreign equity
in private insurance companies – 26 per cent to foreign companies and
14 per cent to non-resident Indians (NRIs), overseas corporate bodies
(OCBs) and foreign institutional investors (FIIs).
• In 1999, the limit of the foreign equity in private insurance companies
was, however, fixed at 26 per cent, and the IRA Act, 1996 was replaced
by IRDA Act, 1999.
• The Insurance Regulatory and Development Act of 1999 was set out to
provide for the establishment of an Insurance Regulatory and
Development Authority (IRDA) to protect the interests of the insurance
policyholders, to regulate, promote and ensure orderly growth of the
insurance industry and for matters connected therewith or incidental
thereto and further to amend Insurance Act, 1938, the Life Insurance
Corporation Act, 1956, and the General Insurance Business
(Nationalisation) Act, 1972.
• In accordance with the provisions of the IRDA Act, the Authority had
formed an Insurance Advisory Committee and, in consultation with the
Committee, it had recommended different regulations in various areas
like registration of insurers, regulation on insurance agents, fixation of
solvency margin, re-insurance schemes, investment and accounting
procedures, etc. to protect the interest of the policy holders.
• The IRDA performs its activities to work as a safeguard of the policy
holders’ interest in the Indian insurance sector. Its main functions are:
• It has notified Protection of Policyholders Interest Regulation, 2001 to
bring in transparency in terms and conditions of different policies and
claim settlement issues;
• It observes the performances of Tariff Advisory Committee;
• It fixes the responsibilities of the insurance surveyors and loss assessors;
• It ensures regulations and other formalities to operate insurance
business in India by any private or public company; and
• It works as a grievance cell for any complaints received from any
policyholder in connection with any insurance provider under the
insurance contract.
• The name of IRDA has changed as IRDA of India (IRDAI) WEF December
30, 2014.
• Until 1999, no private insurance company was allowed to operate in
India.
• The sector was opened up in August 2000 and global insurance giants
started entering this sector.
• When India took initiative for privatisation of insurance sector, it had
two alternatives: (i) selling of PSS (LIC and GIC) to private companies and
(ii) allowing private sector to enter this sector and make friendly
competition with the existing PSS.
• But India considered the second option, and LIC and GIC were
untouched which make the coexistence of public and private sectors
thereby strengthening competition and benefitting the Indian economy.
• Foreign equity, however, is restricted to 26 per cent in any insurance
company.
• At the same time, in a few joint ventures, Indian banks as well as non-
banking financial companies shared the domestic equity portion with
foreign partners in life and non-life insurance areas.
• The process of reforms initiated with the constitution of IRDA has been
smooth, and has facilitated constructive transition from controlled
monopoly to liberated and open insurance business environment.
• It has combined the skills of the public sector insurance companies with
those of the private insurers who have set up operations in collaboration
with foreign joint partners in both life and non-life areas.
• This process has ushered in various types of innovation in the insurance
products specifically designed to meet the customers’ needs.
• Public sector non-life insurers were delinked from their subsidiaries and
has been made the national re-insurer.
• Moving forward on the foundation laid in the initial years of its
operations, the Authority has taken a number of initiatives to develop
the insurance market.
• Broadly these include initiatives at building customer confidence
through a regulatory framework; expansion of coverage through
customer awareness campaigns and through expansion of the customer
reach; encourage insurers to launch innovative products; introduction of
computerization and electronic technology in the system so as to speed
up the process of transactions and settlements and by simplifying
procedures for accessing insurance services.
Recent Initiatives
Amendment to Insurance Legislation:
• The Insurance Laws (Amendment) Bill, introduced in the Parliament in
2008, proposes to amend Insurance Act, 1938, the Insurance Regulatory
and Development Authority Act, 1999 and the General Insurance
Business (Nationalisation) Act, 1972.
• The Bill further proposes to raise foreign equity participation from 26
per cent to 49 per cent, which has already been cleared by the
Government, but the official amendments are likely to be introduced in
the Parliament.
• The Bill also provides to permit foreign re-insurers to open branches only
for re-insurance business in India.
• The amendments to the Insurance Act and IRDA Act provide for more
flexibility in operations and are aimed at deletion of certain sections
which are no longer relevant in the present context. The amendments
 also provide for enhancement of enforcement powers and levy of
stringent penalties.
• In order to expand the scope and coverage of the insurance services (life
and non-life) in the country, the Government is taking initiatives like
faster approvals under use and file system for standard products and
relaxations in investments in debt instruments and other issues relating
to service and indirect taxation.
• The Insurance Laws Amendment Bill, 2008 could not be taken up for
discussion despite being approved by the Select Committee of the Upper
House because of the uproar by opposition parties.
• The Government, however, increased foreign investment limit to 49 per
cent from 26 per cent in insurance through an Ordinance.
Portability of Health Insurance:
• The IRDA has issued guidelines in 2011 for implementing portability of
health insurance policies amongst non-life insurance companies.
• Under these guidelines, the health insurance policyholder can, at the
time of renewal, switch either from one insurance company to another
insurance company of his choice; or from one insurance plan to another
insurance plan with the same insurance company.
• By the process, the policy holder will not lose the credits gained in terms
of waiting periods for pre-existing conditions, time-bound exclusions,
etc.
• The Health Insurance Policy Holder can at the time of Renewal of his
policies can shift to another Insurance Company for a similar product, if
he is not satisfied with the present Insurance Company for any reason,
without losing the Credits gained, if renewed with the existing company.
• This was not the case earlier; because change in insurance company or
plans amounted to loss of these credits and the policies started as new,
carrying all time limitations afresh.
• Thus “Portability” helps to have a level playing field for all insurance
companies and the Customer can choose and compare benefits across
products and Companies.
• IRDA has also provided a portability portal facilitating easy data transfer
between the insurance companies.
Innovations in Health Insurance:
• With increasing demand, the health insurance industry has introduced
innovative products to enable the policyholder to plan comprehensive
protection against health eventualities by combining hospitalisation
indemnity products with supplementary covers or additional policies to
meet specific needs of the policyholder.
• There are products available that provide Daily Hospital Cash benefit in
the form of fixed daily allowance which could be used to cover the
incidental costs associated with hospitalisation (like travel and stay costs
of an attendant).
• These benefits are available either on standalone basis or as optional
component of a packaged health insurance policy.
• Though most of the health policies offered are annually renewable,
insurance companies are finding innovative ways to establish long term
arrangements with the policyholder by offering long term policies or by
incentivising timely renewals, free health check-ups, loyalty vouchers for
OPD covers, etc.
• The innovative covers offered by the health insurance industry have to
some extent blurred the lines between life and non-life covers.
• Recently, the Authority has allowed insurance companies to offer pure
term life insurance products along with health insurance products under
the umbrella of a single product.
• The recent initiatives seek to cover more areas of medicine such as
AYUSH and special provisions for senior citizens.
Micro Insurance:
• One of the main objectives of promoting financial inclusion packages is
to economically empower those sections of society who are otherwise
denied access to financial services, by providing banking and credit
services thereby focusing on bridging the rural credit gap.
• Vulnerability to various risk factors is one of the fundamental attributes
of these sections of the society.
• Lack of protective elements may, thus, not serve the objective of
promoting financial inclusion packages as the targeted sections may fall
back into the clutches of poverty in the event of unforeseen
contingencies.
• Hence, to provide a hedge against these unforeseen risks, micro
insurance is widely accepted as one of the essential ingredients of
financial inclusion packages.
• Micro insurance regulations issued by IRDA have provided a fillip in
propagating micro insurance as a conceptual issue.
• The micro insurance regulations have been made effective from 2005.
• These regulations are in addition to the obligations for rural and social
sector business to be done by all insurers on an annual basis.
• The main thrust of micro insurance regulations is protection of low
income people with affordable insurance products to help cope with and
recover fromcommon risks with standardised popular insurance
 products adhering to certain levels of cover, premium and benefit
standards.
• These regulations have allowed Non-Governmental Organisations
(NGOs) and SelfHelp Groups (SHGs) to act as agents to insurance
companies in marketing the micro insurance products and have also
allowed both life and non-life insurers to promote combi-micro
insurance products.
• TheAuthority recently permitted several additional entities like District
Co-operative Banks, Regional Rural Banks,Individual owners of Kirana
shops, etc., who are Banking Correspondents to be appointed as Micro
Insurance agents facilitating better penetration of Micro Insurance
business.
Pradhan Mantri Jan Dhan Yojana:
• Pradhan Mantri Jan Dhan Yojana (PMJDY), targeting comprehensive
financial inclusion, has been launched by PM on 28th of August, 2014.
• The plan envisages universal access to banking facilities with at least one
basic banking account for every household, financial literacy, access to
credit, insurance and pension facility. In addition, the beneficiaries
would get RuPay Debit card having inbuilt accident insurance cover of
Rs.1 lakh.
• The plan also envisages channeling all Government benefits (from
Centre / State / Local Body) to the beneficiaries accounts and pushing
the Direct Benefits Transfer (DBT) scheme of the Union Government.
• The technological issues like poor connectivity, on-line transactions will
be addressed. Mobile transactions through telecom operators and their
established centres as Cash Out Points are also planned to be used for
Financial Inclusion under the Scheme.
Obligation of Rural and Social Insurance:
• The Regulations framed by the Authority on the obligations of the
insurers towards rural and social sector stipulate targets to be fulfilled
by insurers on an annual basis.
• In terms of these regulations, insurers are required to cover year wise
prescribed targets(i) in terms of number of lives under social
obligations;and (ii) in terms of percentage of policies to be underwritten
and percentage of total gross premium income written directly by the
life and non-life insurers respectively under rural obligations.
Measures in Pension Business:
• The Authority notified IRDA (Linked Insurance Products) Regulations,
2013 and IRDA (Non-Linked Insurance Products) Regulations, 2013
 wherein specific provisions have been envisaged in respect of pension
products.
• The salient features of the regulatory framework include features such
as that all individual pension products have explicitly defined assured
benefit that is payable on death and on vesting; insurers may have an
insurance cover throughout the deferment period or may offer riders;
options available to policyholders on surrender and vesting; options
available to nominees on death of the policyholder; an illustrative target
purchase price for each policyholder considering the premium payment
capacity, age,vesting age and the future expected conditions and
possible risks involved; an illustrative target annuity/pension rates for
the illustrative target purchase price and possible risks involved.
Varishtha Pension Bima Yojana:
• The revived Varishtha Pension Bima Yojana (VPBY) was formally
launched by the Finance Minister on 14.08.2014 and will be open during
the window stretching from 15th August, 2014 to 14th August, 2015 for
the benefit of citizens aged 60 years and above.
• The scheme will be administered by LIC.
• The subscription to the scheme is likely to create a corpus of more than
Rs. 10,000 crore, and would thus also be a significant source of resource
mobilization for the development of the country.
• Pension would be on immediate annuity basis in monthly, quarterly,
half-yearly or annual mode, varying, respectively, between Rs. 500 to
5000 (monthly), Rs. 1500 to 15,000 (quarterly), Rs. 3000 to Rs. 30,000
(half-yearly) and from Rs. 6,000 to Rs. 60,000 (annually), depending on
the amount subscribed and the option exercised.
• The pay-out implies an assured return of 9% on monthly payment basis,
which amounts to an annualized return of 9.38%.
• As on date 2477 beneficiaries have registered and total amount received
is 74.52 crore.
Investments by Insurance Sector:
• During 2009-10, the IRDA aligned the definition of ‘infrastructure facility’
with that of the Reserve Bank of India thereby creating more room for
the insurers to invest in infrastructure sector.
• The Authority has also relaxed the ceiling of investments in
infrastructure to 20 per cent in a “single” investee company as against
10 per cent earlier.
• The limit is applicable to the combination of both debt and equity taken
together without sub ceilings in instruments satisfying certain criteria.
• An additional exposure of 5 per cent has been permitted in ‘debt’ alone
with prior approval of the respective insurer’s Investment Committee.
• Further strengthening on the risk management structure, IRDA has
issued guidelines on the scope for “Internal and Concurrent Audit” for
investment operations of insurance companies to monitor investment of
both traditional and unit linked portfolio, at a closer level with the aim of
mitigating risk.
• Similar stipulations are also applicable to non-life insurance companies.
• The guidelines for audit of Investment Risk Management Systems and
Processes were also issued during the year.
Entry of Banks into Insurance:
• Very recently, all scheduled commercial banks have been allowed to
undertake insurance business by setting up a subsidiary/joint venture, as
well as undertake insurance broking/insurance agency either
departmentally or through a subsidiary subject to the conditions as
specified in the guidelines of RBI and regulations of IRDAI.
• However, only one entity in the group can undertake insurance
distribution by corporate agency or broking mode.
Initiatives at Enhancing Public Disclosures:
• With a view to improving transparency in operations, the Authority has
been working towards enhancing disclosures to be made by insurance
companies on periodic basis.
• A major step in this direction has been the issuance of disclosure
guidelines in January, 2010.
• The stipulations on disclosures to be made by insurance companies have
been strengthened by the Authority to fill the gap in availability of
information in the public domain.
• These disclosures are required to be made through (i) Publication in
Newspapers; and (ii) Hosting on the respective company websites,
effective from the period ended 31st March, 2010.
• This initiative has placed the insurance companies, which are presently
not publicly listed entities, at par with the listed entities in the corporate
world in terms of public disclosures.
• Listed corporate entities are governed by the terms of the Listing
Agreement, which amongst other things provides for public disclosure of
performance on a quarterly basis.
Initiatives at AML/CFT and FATF:
• The Anti-Money Laundering (AML) and Combating the Financing of
Terrorism (CFT) guidelines for the insurance sector were issued in March
2006.
• Post India’s membership into the Financial Action Task Force (FATF) in
June 2010, India has been working on the Action Plan committed to
FATF Secretariat.
• The Authority has accomplished various action points relevant to
Insurance Sector including the one requiring effective mechanisms on
Sharing of Information.
• The Authority has now become a signatory to the Multilateral
Memorandum of Understanding (MMoU) of International Association of
Insurance Supervisors (IAIS) which provides an international platform for
cooperation and sharing of information.
Initiatives for Opening of Foreign Insurance Companies:
• The Authority issued guidelines in May, 2013 for permitting Indian
insurers to open foreign insurance company (including branch office) for
life, general and reinsurance business.
• The eligibility criteria has been put in place by the Authority for insurers
to commence foreign operations.
• These criteria include, three years of operational experience by the
Indian insurance company, networth of Rs.500 crore, Rs.250 crore and
Rs.750 crore for life, non-life and reinsurance companies respectively,
compliance with the solvency requirement as prescribed by the
Authority, and profit for the last 3 years out of the last 5 years.
• The foreign offices should also be compliant of Anti Money Laundering
guidelines and Foreign Exchange Management Act.
Miscellaneous Measures:
• Besides the broad initiatives discussed above, some additional measures
are undertaken regularly by the IRDA to ensure transparency in and
better management of insurance services.
• These measures include data warehouse and data standards, variable
insurance products, credit insurance, corporate governance guidelines
for insurance companies, expansion of insurance business, increasing
the distribution channel, agency distribution, grievance redressal and
consumer awareness, insurance repository system, insurance clearing
house and detection of frauds.
Pension System in India:
• Pension policy in India has traditionally been based on financing through
employer and employee participation.
• As a result, the coverage has been restricted to the organised sector and
a vast majority of the work force in the unorganised sector has been
denied access to formal channels of old age financial support.
 • Only about 12 per cent of the total working population in India is
covered by some form of retirement benefit scheme.
• Besides the problem of limited coverage, the existing mandatory and
voluntary private pension system is characterised by limitations like
fragmented regulatory framework, lack of individual choice and
portability and lack of uniform standards. High incidence of
administrative cost and low real rate of returns characterise the existing
system which has become unsustainable.
Pension Framework:
• Broadly speaking, there are following categories of pension in India in
operation.
• Civil Services Pension Scheme.
• Employees’ Provident Fund Scheme.
• Employees’ Pension Scheme.
• Special Provident Funds.
• New Pension Scheme.
• The Civil Servants’ Pension (CSP) is a traditional defined benefit scheme
which runs on the basis of pay-as-you-go-system, for employees of
Central Government who were recruited up to 31st December, 2003 and
employees of State Governments recruited up to the effective date
mentioned in notifications issued by those governments.
• CSP is an unfunded scheme and there has been no attempt at building
up pension assets through contribution or any other provision.
• CSP scheme is indexed to wages and inflation.
• A modified one rank one-wage principle applies to it wherein all retired
employees of a certain rank get the same pension.
• The main problem under CSP is that of fiscal stress.
• For the organized sector employees, the basic structure of pension and
other retirement benefits has been outlined in the Employees Provident
Funds (EPF) and Miscellaneous Provisions (MP) Act, 1952.
• The provisions of this Act are applicable to all defined establishments,
employing more than 20 workers and cover about 43 million employees
in the organized sector.
• This Act remained unquestioned and there were virtually no changes in
the contribution, administration and benefits being provided under this
Act for almost four decades.
• First major change occurred in 1995, with the conversion of part of
defined contribution EPF Scheme to a defined benefit scheme in the
form of Employees’ Pension Scheme.
 • This change in the EPF & MP Act, 1952 marked an important break from
the existing policy of the Employees Provident Fund Organisation in two
ways:
• (a) With this amendment, the concept of a mandated annuity to the
employees of private sector was introduced for the first time.
• (b) It added a new pension liability (since the scheme is not fully funded)
to the existing liability with regard to the civil servants of Central and
State Governments.
• The EPF & MP Act, 1952 is administered by an organization titled the
Employees Provident Fund Organization (EPFO). At present, EPFO
administers the following two pension schemes, which are mandatory
for all employees in the organized sector, earning a monthly salary of
less than Rs.6,500/-:
• (a) The Employees Provident Fund (EPF); and
• (b) The Employees Pension Scheme (EPS).
• The Employees Provident Fund (EPF) Scheme is an individual account
defined contribution scheme wherein both the employees and employer
contribute to the fund at the rate of 12 per cent of the employee’s pay.
• There are number of provisions under the scheme for pre-mature
withdrawal of accumulation.
• This pre-mature withdrawal provision is frequently used by the members
of the scheme which leads to small balances at the time of their
superannuation.
• Because of low balance in individual account, the members’ old age
income benefit is negligible.
• The EPFO scheme enjoys an ‘EEE’ tax structure which constitutes a major
tax based subsidy.
• The Employees Pension Scheme (EPS) is a defined benefit scheme, based
on a contribution rate of 8.33 per cent from the employee to which
government makes an additional contribution of 1.16 per cent.
• EPS was introduced in 1995, and is applicable to the workers who
entered into employment after 1995.
• In case of death of a member, the scheme provides for a pension to the
spouse for his/her remaining life.
Pension Reforms:
• Given the limitations of various pension schemes and growing fiscal
stress, three reports had initially come up to examine the issue of old
age financial security.
• These are: Project OASIS Committee Report (1999), IRDA Report (2001)
on Pensions Reforms in the Unorganised Sector, and Report of the High
 Level Expert Group on New Pensions System by the Government of India
(2002).
• The first report was prepared by a private organisation (called OASIS),
while the other two reports by the government authorities provide
roadmaps for pension reforms based on OASIS Report.
• OASIS report recommended a scheme based on Individual Retirement
Accounts to be opened anywhere in India.
• It was envisaged that Banks, Post Offices etc., could serve as “Points of
Presence” (POPs) where the accounts could be opened or contributions
deposited.
• Their electronic interconnectivity would ensure “portability” as the
worker moves from one place/employment to another.
• There would be a depository for centralised record keeping, fund
managers to manage the funds and annuity providers to provide the
benefit after the age of 60.
• The IRDA in its report on pension reforms in the unorganised sector in
2001 identified the following reasons for reforming the pension sector.
• 1. Government and state owned enterprises as employers were finding
it difficult to fund their pensions liabilities.
• 2. EPFO and employers’ managed funds were return inefficient, service
deficient and not in a position to meet their liabilities.
• 3. Private companies, particularly insurance and fund managements,
were waiting in the wings at the prospect of handling investible funds.
• While pension reforms in most countries initially are driven by the
budgetary difficulties of supporting costly public pension systems, the
longer term problems of aging of the population and social change,
including breakdown of traditional family support for old age income
security, are equally important factors.
• There were series of budget announcements starting from 2001-02
underlining need for pension reforms for both Central Government and
for unorganised sector.
• The Government has introduced a new pension system (NPS) from 1st
January 2004 for new entrants to Central Government service, except
Armed Forces.
• The Government constituted an Interim Pension Fund Regulatory and
Development Authority (IPFRDA) as a precursor to the statutory
regulator.
• The Pension Fund Regulatory and Development Authority Act was
passed on 19th September, 2013 and the same was notified on 1st
February, 2014.
• PFRDA is regulating NPS, subscribed by employees of Govt. of India,
State Governments and by employees of private
institutions/organizations & unorganized sectors.
• The new pension system (NPS) is a restructured defined contribution
pension system for new entrants to Central Government service, except
to Armed Forces, in the first stage, replacing the then existing system of
defined benefit pension system.
• The new system was also available on a voluntary basis, to all persons,
including self employed professionals and others in the unorganised
sector.
• However, mandatory programmes under the EPFO and other special
provident funds would continue to operate as per the existing system
under the EPF and MP Act, 1952 and other special Acts governing these
funds.
• The main features of NPS are given below.
• The new pension system would be based on defined contributions,
which will use the existing network of bank branches and post offices
etc. to collect contributions and interact with participants allowing
transfer of the benefits in case of change of employment and offer a
basket of pension choices.
• The system would be mandatory for new recruits to the central
Government service except the armed forces and the monthly
contribution would be 10 percent of the salary and DA to be paid by the
employee and matched by the Central Government. However, there will
be no contribution from the Government in respect of individuals who
are not Government employees. The contributions and investment
returns would be deposited in a non-withdrawable pension tier-I
account. The existing provisions of defined benefit pension and GPF
would not be available to the new recruits in the central Government
service.
• In addition to the above pension account, each individual may also have
a voluntary tier-II withdrawable account at his option. This option is
given as GPF which is proposed to be withdrawn for new recruits in
Central Government service. Government will make no contribution into
this account. These assets would be managed through exactly the above
procedures. However, he would be free to withdraw part or all of the
‘second tier’ of his money anytime. This withdrawable account does not
constitute pension investment, and would attract no special tax
treatment.
• Individuals can normally exit at or after age 60 years for tier –I of the
pension system. At exit the individual would be mandatorily required to
invest 40 per cent of pension wealth to purchase an annuity (from an
IRDA-regulated life insurance company). In case of Government
employees the annuity should provide for pension for the lifetime of the
employee and his dependent parents and his spouse at the time of
retirement. The individual would receive a lumpsum of the remaining
pension wealth, which he would be free to utilise in any manner.
Individuals would have the flexibility to leave the pension system prior
to age 60. However, in this case, the mandatory annuitisation would be
80 per cent of the pension wealth.
• NPS has also been extended to new segments (autonomous bodies,
State Governments and unorganised sector) introducing micro-pension
initiatives.
• NPS has been adopted resoundingly by the State Governments.
• 27 State Governments and Union Territories have notified adoption of
NPS for their new employees.
• 25 State Governments and Union Territories have executed agreement
with Central Recordkeeping and Accounting Agency (CRA) and have also
executed agreement with NPS Trust.
• 11 State Governments have registered their nodal offices and
subscribers with CRA.
• 22 State Governments have started uploading data and 18 State
Governments transferring contribution amount in NPS.
• In order to expand the reach of the NPS countrywide, PFRDA involved
the postal department in 2009.
• The subsequent initiatives undertaken include:
• adding a Tier II to the NPS that will serve as a savings account for the
pension subscriber with effect from 1st December, 2009;
• development of CRA- Lite - a low cost version of NPS meant to enrol
people of lower economic strata like self help groups, affinity groups
etc.;
• It has also been approved to increase the maximum entry age under the
NPS to 60 years, as against the prevailing 55 years to enable more
people to join the NPS;
• Under the NPS for all citizens, a subscriber has the facility to open NPS
account at any of the registered branches of the 36 PoPs appointed by
Interim PFRDA.
• To encourage the people from the unorganised sector to voluntarily save
for their retirement and to lower the cost of operations of the New
 Pension Scheme (NPS) for such subscribers, the Government has
proposed to contribute Rs. 1000 per year to each NPS account opened in
the year 2010-11. State governments have also been asked to contribute
similar amount.
• This initiative, “Swavalamban” is proposed to be made available for
persons who join NPS, with a minimum contribution of Rs. 1000 and a
maximum contribution of Rs. 12000 per annum during a financial year.
• The then Hon’ble Finance Minister, Shri Pranab Mukherjee has launched
the Swavalamban Scheme on 26.09.2010 at Jangipur (West Bengal).
• The scheme is being managed by the Pension Fund Regulatory and
Development Authority.
• The Swavalamban Scheme was initially announced for three years for
the beneficiaries who enrolled themselves in 2010-11. It has now been
extended to five years for the beneficiaries enrolled in 2010-11, 2011-12
and 2012-13.
• The Scheme operates through 50 Aggregators and 48 PoPs.
• This scheme is open to those citizens of India who are not part of any
pension/provident scheme.
• In view of the encouraging response to the Scheme, relaxations have
been provided in the exit norms of the Scheme, whereby a subscriber
under Swavalamban will be allowed exit at 50 years (instead of the
existing prescribed age of 60 years) or a minimum tenure of 20 years,
whichever is later.
• The per capita Incentive payable to Aggregators has been revised from
Rs.50 to Rs.100.
• Further, the incentive for promotion efforts based on volume has also
been revised.
Exchange Rate:
• The exchange rate is a key financial variable that affects decisions made
by foreign exchange investors, exporters, importers, bankers,
businesses, financial institutions, policymakers and tourists in the
developed as well as developing world.
• Exchange rate fluctuations affect the value of international investment
portfolios, competitiveness of exports and imports, value of
international reserves, currency value of debt payments, and the cost to
tourists in terms of the value of their currency.
• Movements in exchange rates thus have important implications for the
economy’s business cycle, trade and capital flows and are, therefore,
crucial for understanding financial developments and changes in
economic policy.
Exchange Rate Regimes:
• Exchange rate regime governs its exchange rate—that is, how much its
own currency is worth in terms of the currencies of other countries.
• The exchange rate regime has a big impact on world trade and financial
flows and the volume of such transactions and the speed at which they
are growing highlight the crucial role of the exchange rate in today’s
world, thereby making the exchange rate regime a central piece of any
national economic policy framework.
Types of Exchange Rate Regimes:
• Exchange rate regimes are typically divided into three broad categories.
• At one end of the spectrum are hard exchange rate pegs. these entail
either the legally mandated use of another country’s currency (also
known as full dollarization) or a legal mandate that requires the central
bank to keep foreign assets at least equal to local currency in circulation
and bank reserves (also known as a currency board).
• Panama, which has long used the U.s. dollar, is an example of full
dollarization, and Hong Kong SAR (Specified Administrative Region)
operates a currency board.
• Hard pegs usually go hand in hand with sound fiscal and structural
policies and low inflation.
• They tend to remain in place for a long time, thus providing a higher
degree of certainty for pricing international transactions.
• However, the central bank in a country with a hard exchange rate peg
has no independent monetary policy because it has no exchange rate to
adjust and its interest rates are tied to those of the anchor-currency
country.
• In the middle of the spectrum are soft exchange rate pegs—that is,
currencies that maintain a stable value against an anchor currency or a
composite of currencies.
• The exchange rate can be pegged to the anchor within a narrow (+1 or –
1 per cent) or a wide (up to +30 or –30 per cent) range, and, in some
cases, the peg moves up or down over time—usually depending on
differences in inflation rates across countries.
• Costa Rica, Hungary, and China are examples of this type of peg.
• Although soft pegs maintain a firm “nominal anchor” (that is, a nominal
price or quantity that serves as a target for monetary policy) to settle
inflation expectations, they allow for a limited degree of monetary policy
flexibility to deal with shocks.
• However, soft pegs can be vulnerable to financial crises—which can lead
to a large devaluation or even abandonment of the peg—and this type
of regime tends not to be long lasting.
• At the other end of the spectrum are floating exchange rate regimes.
• As the name implies, the floating exchange rate is mainly market
determined.
• In countries that allow their exchange rates to float, the central banks
intervene (through purchases or sales of foreign currency in exchange
for local currency) mostly to limit short-term exchange rate fluctuations.
• However, in a few countries (for example, New Zealand, sweden,
Iceland, the United states, and those in the euro area), the central banks
almost never intervene to manage the exchange rates.
• Floating regimes offer countries the advantage of maintaining an
independent monetary policy.
• In such countries, the foreign exchange and other financial markets must
be deep enough to absorb shocks without large exchange rate changes.
• Also, financial instruments must be available to hedge the risks posed by
a fluctuating exchange rate.
• Almost all advanced economies have floating regimes, as do most large
emerging market countries.
Case of India: In the post independence period, India’s exchange rate
policy has seen a shift from a par value system to a basket-peg and further
to a managed float exchange rate system.
Par Value System (1947-1971):
• During the period 1947 till 1971, India followed the par value system of
the exchange rate whereby the rupee’s external par value was fixed at
4.15 grains of fine gold.
• The RBI maintained the par value of the rupee within the permitted
margin of ±1% using pound sterling as the intervention currency.
• The devaluation of the rupee in September 1949 and June 1966 in terms
of gold resulted in the reduction of the par value of rupee in terms of
gold to 2.88 and 1.83 grains of fine gold, respectively.
• In terms of currencies, the exchange rate of the rupee, whichh had
been historically linked to pound sterling, was fixed at Rs.13.33 per
pound sterling (or Rs.4.76 per US dollar) in September 1949. This
remained unchanged up to June 1966 when the rupee was devalued by
36.5 per cent to Rs.21 per pound sterling (or 1 US $ = Rs.7.50).
• Since 1966, the exchange rate of the rupee remained constant till 1971
when the suspension of the convertibility of the US dollar brought the
era of Bretton Woods to an end.
Pegged Regime (1971-1992):
• The peg currency was the US dollar from August 1971 to December 1971
followed by pound sterling from December 1971 to September 1975.
• With the breakdown of the Bretton Woods System, in December 1971,
the rupee was linked with pound sterling.
• Sterling being fixed in terms of US dollar under the Smithsonian
Agreement of 1971, the rupee also remained stable against dollar.
• It should, however, be noted here that the collapse of the Bretton
Woods system resulted in the downward pressure on pound sterling vis-
à-vis major international currencies. Further, the historical importance
of the United Kingdom in India’s trade had declined over the years.
• In order to overcome the weaknesses associated with a single currency
peg and to ensure stability of the exchange rate, the rupee, with effect
from September 1975, was pegged to a basket of currencies of the then
India’s major trading partners.
• The currencies included in the basket as well as their relative weights
were at the discretion of the Reserve Bank of India subject to the
approval of the Government of India.
• These were kept confidential to discourage speculation.
• During the 1980s, the exchange rate was actively used as a policy
instrument to achieve a sustainable current account deficit by ensuring
improvements in the price competitiveness of exports.
• Accordingly, the period beginning from 1983-84 and 1984-85 was
marked by continuous downward adjustment in the external value of
the rupee.
• By the late 80s and the early 90s, it was, however, recognised that both
macroeconomic policy and structural factors had contributed to balance
of payment difficulties. The current account deficit widened to 3 per
cent of GDP in 1990-91 and the foreign currency assets depleted to less
than a billion dollar by July 1991.
• The Reserve Bank, therefore, effected a two step downward exchange
rate adjustment by 9 per cent and 11 per cent between July 1 and 3,
1991 to counter the massive draw down in the foreign exchange
reserves, to install confidence in the investors and to improve domestic
competitiveness.
• The depreciation of the rupee, however, was not an isolated event, but
was an integral part of an overall stabilisation and structural
programmes to reform India’s external sector policies and to generate
impulses for growth.
 • The two-step adjustment of July 1991 effectively brought to a close the
period of pegged exchange rate.
Liberalised Exchange Rate Management System (1992-93):
• While the sharp downward adjustments of July 1991 corrected the
misalignment in the rupee, it provided necessary impetus for allowing
greater exchange rate flexibility.
• The further transition to the market based system of exchange rate was
sequenced on the basis of the Report of the High Level Committee on
Balance of Payments (Chairman Dr. C. Rangarajan) in 1993.
• With regard to the exchange rate policy, the committee recommended
that consideration be given to (i) a realistic exchange rate, (ii) avoiding
use of exchange mechanisms for subsidization, (iii) maintaining
adequate level reserves to take care of shortterm fluctuations, (iv)
continuing the process of liberalization on current account, and (v)
reinforcing effective control over capital transactions.
• The key to the maintenance of a realistic and a stable exchange rate is
containing inflation through macro-economic policies and ensuring net
capital receipts of the scale not beyond the expectation.
• The Committee further recommended the introduction of a dual
exchange rate system, which could over time, graduate to a fully
convertible market determined unified exchange rate.
• Following the recommendations of Rangarajan Committee to move
towards the market-determined exchange rate, the Liberalised Exchange
Rate Management System (LERMS) was put in place in March 1992
through partial convertibility of the rupee involving dual exchange rate
system in the interim period.
• Under the dual exchange rate system, 40 per cent of the current receipts
were required to be surrendered to the Reserve Bank at the official
exchange rate while the rest 60 per cent were converted at the market
exchange rate.
• The 40 per cent portion was utilised to meet the essential imports at a
lower cost.
• The experience with the dual exchange rate system in terms of market
volatility was satisfactory.
• A dual exchange system like the LERMS, however, involved an implicit
tax on exports and other invisible receipts and was a source of distortion
in the efficient allocation of resources.
Market Determined Exchange Rate Regime (1993 till date):
• The stability imparted by the LERMS, the significant easing in the rate of
inflation and a healthy build-up of foreign exchange reserves enabled a
 smooth change over to a regime under which the exchange rates were
unified effective March 1, 1993.
• The day-to-day movements in exchange rates have been since then
largely market determined.
• The objective of exchange rate management has been to ensure that the
external value of the rupee is realistic and credible.
• Subject to this predominant objective, the exchange rate policy is guided
by the need to reduce excess volatility, prevent the emergence of
destabilising speculative activities, help maintain adequate level of
reserves, and develop an orderly foreign exchange market.
Institutional Development:
• The movement to the market determined exchange rate was
accompanied by convertibility on current account and a cautious
approach to capital account liberalisation.
• Restrictions on current account transactions were relaxed in a phased
manner culminating in current account convertibility of the rupee on
August 24, 1994 as India accepted obligations under Article VIII of the
IMF’s Articles of Agreements.
• The management of the capital account involved management of
control, regulation and liberalisation.
• Recognising that an important ingredient for the market determination
of the exchange rate is the depth of the foreign exchange market, efforts
have been made to enhance the depth of the market.
• Flexibility to market operators has been provided through the
introduction of various derivative products to hedge their asset-liability
portfolio.
• Further more, aggregate gap limits and open position limits of Ads have
been freed of quantitative ceilings and have been related to capital, risk
taking capacity, balance sheet size and other relevant parameters.
• In order to promote integration of domestic and foreign exchange
markets, the limits on borrowing and investment overseas of banks have
been progressively liberalised.
• Exporters were allowed to maintain foreign currency accounts for
operational flexibility.
• Resident Indians have also been extended the facility of foreign currency
accounts and allowed to invest abroad subject to specified guidelines.
• Corporates are being extended the facility to raise external commercial
borrowings under the automatic route subject to transparent caps, and
have been allowed greater flexibility to prepay their borrowings.
 • With a view to promoting orderly development of foreign exchange
markets and facilitating external payments in a liberalised regime, the
Foreign Exchange Management Act (FEMA) was introduced from June 1,
2000 replacing the earlier Foreign Exchange Regulation Act (FERA).
Interventions:
• In the post-Asian crisis period, particularly after 2002-03, capital flows
into India surged creating space for speculation on Indian rupee.
• The Reserve Bank intervened actively in the forex market to reduce the
volatility in the market.
• During this period, the Reserve Bank made direct interventions in the
market through purchases and sales of the US Dollars in the forex
market and sterilised its impact on monetary base.
• The Reserve Bank has been intervening to curb volatility arising due to
demand-supply mismatch in the domestic foreign exchange market and
to smoothen jerky movements.
• The volatility of Indian rupee remained low against the US dollar than
against other major currencies as the Reserve Bank intervened mostly
through purchases/sales of the US dollar.
• The intervention of the Reserve Bank in order to neutralise the impact of
excess foreign exchange inflows enhanced the RBI’s Foreign Currency
Assets (FCA) continuously.
• In order to offset the effect of increase in FCA on monetary base, the
Reserve Bank had mopped up the excess liquidity from the system
through open market operation.
• It is, however, pertinent to note that Reserve Bank’s intervention in the
foreign exchange market has been relatively small in terms of volume
(less than 1 per cent during last few years), except during 2008-09.
• The Reserve Bank’s gross market intervention as a per cent of turnover
in the foreign exchange market was the highest in 2003-04 though in
absolute terms the highest intervention was US$ 84 billion in 2008-09.
• During October 2008 alone, when the contagion of the global financial
crisis started affecting India, the RBI sold US$ 20.6 billion in the foreign
exchange market.
• This was the highest intervention till date during any particular month.
Impossible Trinity Theory:
• A key challenge for macroeconomic policy in open economies is how to
simultaneously manage exchange rates, interest rates and capital
account openness-the trilemma.
• This trilemma is popularly known as the “Impossible Trinity”.
 • The impossible trinity theorem asserts that under any macroeconomic
circumstances, it is impossible to achieve following three desirable goals
simultaneously: exchange rate stability, capital market integration and
monetary autonomy.
• Any pair of goals is achievable by choosing a suitable payment regime
but requires the abandoning of the third.
• Specifically:
• (i) Exchange stability and capital market integration can be combined by
adopting a fixed exchange rate but requires giving up monetary
autonomy. The authorities lose the power to vary the home interest rate
independently of the foreign interest rate.
• (ii) Monetary autonomy and capital market integration can be combined
by floating the exchange rate but requires giving up exchange stability.
The authorities have freedom to choose the home interest rate but they
must in consequence accept any exchange rate that the market dictates.
• (iii) Exchange stability can be combined with monetary autonomy but
requires giving up capital market integration. In the presence of capital
controls, the interest rate exchange rate link is broken.
• The theorem owes its origin to the Mundell-Fleming Model developed in
the 1960s which analysed the effectiveness of monetary policy in an
open economy (free capital movement) under different exchange rate
regimes.
Impossible Trinity Issue:
• Given the ‘impossible trinity’ trilemma, countries have made different
choices.
• The most common choice, typical across advanced economies, is to give
up on a fixed exchange rate so as to run an open economy with an
independent monetary policy.
• On the other hand, economies that adopt a hard peg give up on the
independence of monetary policy.
• Examples include the currency boards set up by Hong Kong and, for a
time, Argentina.
• In contrast to advanced economies which opt for corner solutions,
emerging economies here typically opted for middle solutions, giving up
on some flexibility on each of the variables to maximize overall
macroeconomic advantage.
India’s Approach to the Impossible Trinity:
• In India too, we have opted for a middle solution on the ‘impossible
trinity’ whose contours are the following:
 • (i) We let our exchange rate be largely market determined, but intervene
in the market to smooth excess volatility and/or to prevent disruptions
to macroeconomic stability;
• (ii) Our capital account is only partly open, while foreigners enjoy mostly
unfettered access to our equity markets, access to debt markets is
restricted, and there are limits to the quantum of funds resident
corporates and individuals can take out for investment abroad, but the
limits are quite liberal; and
• (iii) Because of the liberalization on the exchange rate and capital
account fronts, some monetary policy independence is forefeited. What
the middle solution also implies is that we have to guard on all the three
fronts with the relative emphasis across the three pillars shifting
according to our macroeconomic situation.
India’s Efforts Towards Impossible Trinity:
• Between 2000 and 2008, the Reserve Bank of India intervened heavily in
the foreign exchange market to prevent the rupee from appreciating in
the face of strong capital inflows.
• The increase in foreign exchange stability was associated with less
monetary policy autonomy.
• Since 2008, following the global financial crisis, India had allowed greater
flexibility in the exchange rate by intervening in a very limited manner,
which had acted as a shock absorber during times of volatile capital
flows, and regained monetary independence.
• Monetary policy was predominantly shaped by the domestic growth-
Inflation dynamics over the past two years, although concerns over
worsening external imbalances also had a growing influence on policy
calibration over the past year.
• The RBI has also ensured that the monetary policy is aligned with fiscal
consolidation.
Recent Challenges:
• In the recent time, market expectations of Fed QE tapering and the
consequent increase in real interest rates in the US had fuelled the
concern over capital flight from emerging markets and created
challenging external financing conditions for vulnerable economies such
as India.
• The global financial backdrop and India’s deteriorating external
imbalances (due to trade deficit, current account deficit and large gold
imports) led to a sharp depreciation of the Indian rupee by 17.7 per cent
against the US dollar during mid-May to end-August 2013.
 • The fall in rupee was, however, in line with the currencies of most of the
emerging market economies, especially, countries with current account
deficit.
Measures:
• The Reserve Bank undertook several measures to reduce the availability
of money in the banking system and to curb the volatility in the
exchange rate.
• These measures included:
• Reduction in the availability of liquidity under LAF by 1 per cent and
further by 0.5 per cent,
• Hike in marginal standing facility by 2 per cent,
• Conduct open market operations and
• Banks were asked to set aside a higher amount of cash towards
maintaining cash reserve ratio.
• Besides the measures taken by the RBI and the Government, the Fed’s
decision to maintain (and not to increase) the pace of its QE helped to
recover the situation.
• The opening of a forex swap window for the public sector oil marketing
companies played an important role in stabilising rupee.
• In response to these developments, and due to steps undertaken to
moderate the CAD, the exchange rate, that breached the level of 68 per
US$ in August 2013, recovered to 61.16 per US$ on October 11, 2013.
• The exchange rate of the rupee averaged 61.91 per US$ in December
2013.
Capital Market Reforms: Background:
• The capital markets reforms in 1991 were preceded by a regime which
ensured almost complete control of the state over the financial markets.
• Initial Public Offerings (IPO) were controlled through the Capital Issues
Control Act.
• The Controller of Capital Issues (CCI) controlled the price and quantity of
IPO and trading practices were short of transparency.
• Interest rates were highly regulated, thereby making capital availability
too costly.
• The Unit Trust of India (UTI) created in 1964 was the only mutual fund
and it enjoyed complete monopoly of the mutual fund business up until
1988.
• The resource mobilisation by mutual funds demonstrates UTI’s
dominance in the early 1990s.
 • The early 1990s therefore, was a time when the primary role of the
financial system in India was to channel resources from the excess to the
deficit.
• The role of technology was limited and customer relationship and
service was not a priority.
• Risk management procedures and prudential norms were weak,
affecting asset portfolio and profitability.
• The Bombay Stock Exchange (BSE), the oldest and the largest stock
exchange in India, traded for two hours in a day with an open outcry
system.
• The exchange was managed in the interests of individual members, a
majority of whom had inherited their seats.
• A large proportion of stocks listed on the exchange were not actively
traded.
• There was minimum supervision from the exchanges and speculation
was rampant.
• There were regional exchanges which were unconnected and engaged in
open outcry system of trading.
• Each exchange had a board representative nominated from the Capital
Markets division of the Ministry of Finance, the then regulator of the
capital markets.
Capital Market Reforms:
• The capital market reforms were based on improving two fundamental
aspects.
• First, the improvement in the legal reporting framework and second the
improvement in the technology framework.
• There have been significant reforms in the regulation of the securities
market since 1992 in conjunction with the overall economic and financial
reforms.
• A key element of the reform strategy was building a strong independent
market regulator.
• The SEBI Act, which came into force in early 1992, established SEBI as an
autonomous body.
• The apex capital market regulator was empowered to regulate the stock
exchanges, brokers, merchant bankers and market intermediaries.
• The Act provided SEBI the necessary powers to ensure investor
protection and orderly development of the capital markets.
• The introduction of free pricing in the primary capital market has
significantly deregulated the pricing control instituted by the erstwhile
CCI regime.
• While, the issuers of securities can now raise capital without seeking
consent from any authority relating to the pricing, however the issuers
are required to meet the SEBI guidelines for Disclosure and Investor
Protection, which, in general, cover the eligibility norms for making
issues of capital (both public and rights) at par and at a premium by
various types of companies.
• The freeing of the pricing of issues led to an unprecedented upsurge of
activity in the primary capital market as the corporate mobilised huge
resources.
• However, it did expose the inadequacies of the regulations.
• In order to address these inadequacies, SEBI strengthened the norms for
public issues in April 1996.
• The disclosure standards were enhanced to improve transparency and
uphold the objective of investor protection.
• The issuers are now required to disclose information on various aspects,
such as, the track record of profitability, risk factors, etc.
• Issuers now also have the option of raising resources through fixed price
floatations or the book building process.
• Clearing houses have been established by the stock exchanges and all
transactions are mandatorily settled through these clearing houses and
not directly between the members, as was practiced earlier.
• The practice of holding securities in physical form has been replaced
with dematerialised securities and now the transfer is done through
electronic book keeping, thereby eliminating the disadvantages of
holding securities in physical form.
• There are two depositories operating in the country.
• The margin system, limits on intra-day, trade and settlement guarantee
fund are some of the measures that have been undertaken to ensure the
safety of the market.
• The trading and settlement cycles have been significantly reduced.
• The cycles were initially shortened from 14 days to 7 days.
• The settlement cycles were further shortened to T+3 for all securities in
2002.
• The settlement cycle is now T+2.
• Listed companies are required to furnish unaudited financial results to
the stock exchanges and also publish the same on a quarterly basis.
• To enhance the level of disclosure by the listed companies, SEBI decided
to amend the Listing Agreement to incorporate the segment reporting,
accounting for taxes on income, consolidated financial results,
 consolidated financial statements, related party disclosures and
compliance with accounting standards.
• The last few years have seen significant interaction with the
international capital markets.
• A major step towards that was the inclusion of Foreign Institutional
Investors (FIIs) such as mutual funds, pension funds and country funds to
operate in the Indian markets.
• As a quid pro quo, Indian firms have also raised capital in international
markets through issuance of Global Depository Receipts (GDRs),
American Depository Receipts (ADRs), Euro Convertible Bonds (ECBs),
etc.
• The SEBI’s regulatory realm stretches beyond the stock exchanges to
merchant bankers, registrars, share transfer agents, underwriters,
mutual funds and various other advisors and market intermediaries.
• There have been efforts made to increase transparency in the takeover
process and interests of minority shareholders.
• One of the most noteworthy achievements of the Indian capital markets
over the past 20 years has been the development of the derivative
market.
• It has significantly enhanced the sophistication and maturity of the
market.
• In India, derivative trading began in June 2000, with trading in stock
index futures.
• By the fourth quarter of 2001, each of India’s two largest exchanges had
four equity-derivative products: futures and options for single stocks,
and futures and options for their respective stock indices.
• The NSE has become the largest exchange in single stock futures in the
world, and by June 2007, it ranked fourth globally in trading index
futures, a sign of an evolving and maturing market.
• Market liquidity too has increased greatly since 1992.
• This was primarily attributed to settlement rules and the introduction of
derivatives trading.
• The move from fixed period to rolling settlements, shortened settlement
periods, and a dramatic increase in derivatives trading contributed to
steadily increasing market liquidity.
• The advent of technology to the markets has been largely attributed to
the National Stock Exchange (NSE).
• NSE introduced the screen based trading and settlement system,
supported by a state-of-the –art technology platform.
• To fulfill the commitment to adopt global best practices and bring about
more transparency to the capital markets functioning, SEBI also assumed
the responsibility of monitoring the markets and stock exchanges.
• A significant step towards that initiative was the launch of the Integrated
Market Surveillance System (IMSS) in 2006.
• The IMSS equipped the regulator to identify doubtful market activity.
• The IMSS’s primary objective is to monitor the market activities across
various stock exchanges and market segments including both equities
and derivatives.
• IMSS collects and analyses data not only from the stock exchanges but
also from National Securities Depository, Limited. (NSDL), Central
Depository Services (India) Limited. (CDSL), clearinghouses, and clearing
corporations.
• The RBI introduced the electronic funds transfer system, “The Reserve
Bank of India National Electronic Funds Transfer System" (referred to as
"NEFT System" or "System").
• The objective of the system is two-fold. First, is to establish an electronic
funds transfer system to facilitate an efficient, reliable, secure and
economical system to funds transfer and clearing in the banking sector
throughout India.
• Second, is to relieve the stress on the paper based funds transfer and
clearing system.
• The wave of economic reforms initiated by the government has
influenced the functioning and governance of the capital market.
• Extensive Capital Market Reforms were undertaken during the 1990s
encompassing legislative regulatory and institutional reforms.
• The chief aim of the reforms exercise was to improve market efficiency,
make stock market transactions more transparent, curb unfair trade
practices and to bring our financial markets up to international
standards.
• Further, the consistent reforms in Indian capital market, especially in the
secondary market resulting in modern technology and online trading
have revolutionized the stock exchanges.
• The Securities and Exchange Board of India (SEBI), which came into
existence in 1988, was given statutory power under SEBI Act, 1992 and
was thus designated as an apex market regulator to regulate the
collective investment schemes and plantation schemes through an
amendment in 1999.
• Further, the organization strengthening of SEBI and suitable
empowerment through compliance and enforcement powers including
 search and seizure powers were given through an amendment in SEBI
Act in 2002.
• Three creditors rating agencies, Viz., The Credit Rating Information
Services of India Limited (CRISIL) in 1988, The Investment Information
and Credit Rating Agency of India Limited (ICRA) in 1991 and Credit
Analysis and Research Limited (CARE) in 1993 were set up in order to
assess the financial health of different financial institutions and agencies
related to the stock market activities.
• A series of reforms were introduced to improve investor’s protection,
automation of stock trading, integration of national markets and
efficiency of market operations.
• SEBI in 1993 initiated a significant move which involved the shift of all
exchanges to screen-based trading being motivated primarily by the
need for greater transparency.
• The first exchange to be based on an open electronic limit order book
was the National Stock Exchange (NSE), which started trading debt
instruments in June 1994 and equity in November 1994. In March 1995,
Bombay Stock Exchange (BSE) shifted from open outcry to a limit order
book market.
• Although dematerialisation started in 1997 after the legal foundations
for electronic book keeping were provided and depositories created, the
regulator mandated gradually that trading in most of the stocks takes
place only in dematerialised form.
• Till 2001, India was the only sophisticated market having account period
settlement alongside the derivatives products. From middle of 2001
uniform rolling settlement and same settlement cycles were prescribed
creating a true spot market.
• After the legal framework for derivatives trading was provided by the
amendment of Securities Contract Regulation Act, 1956 (SCRA) in 1999,
derivatives trading started in a gradual manner with stock index futures
in June 2000.
• Later on options and single stock futures were introduced in 2000-2001
and now India’s derivatives market turnover is more than the cash
market and India is one of the largest single stock futures markets in the
world.
• India's risk management systems have always been very modern and
effective. The value at risk (VaR) based margining system was introduced
in mid 2001 and the risk management systems has withstood huge
volatility experienced in May 2003 and May 2004. This included real
 time exposure monitoring, disablement of broker terminals, VaR based
margining etc.
• India is one of the few countries to have started the screen based
trading of government securities in January 2003.
• In June 2003 the interest rate futures contracts on the screen based
trading platform were introduced.
• India is one of the few countries to have started the Straight Through
Processing (STP), which will completely automate the process of order
flow and clearing and settlement on the stock exchanges.
• RBI has introduced the Real Time Gross Settlement system (RTGS) in
2004 on experimental basis. RTGS will allow real delivery v/s. payment
which is the international norm recognized by BIS and IOSCO.
• To improve the governance mechanism of stock exchanges by
mandating demutualisation and corporatisation of stock exchanges and
to protect the interest of investors in securities market, the Securities
Laws (Amendment) Ordinance was promulgated on 12th October 2004.
The Ordinance has since been replaced by a Bill.
• Out of the 23 erstwhile stock exchanges, 18 have since been
corporatized and demutualised in 2007-08.
• One stock exchange, i.e. Hyderabad Stock Exchange, failed to
demutualise by the due date and has therefore been de-recognized.
• Saurashtra Kutch Stock exchange, Mangalore Stock exchange and
Magadh Stock exchange have been de-recognized for various
irregularities/non compliances.
• As regards Coimbatore Stock Exchange, which had sought voluntary
withdrawal of recognition, the matter is subjudice.
• A new stock exchange MCX was started in February, 2013, which has
started live trading.
• The Government had set up a High-Level Expert Committee on
Corporate Bonds and Securitisation (Patil Committee) to look into legal,
regulatory, tax and market design issues in the development of the
corporate bond market.
• The Committee submitted its report to the Government in December,
2005.
• The Budget of 2006-07 announced that the Government has accepted
the recommendations of the Report and that steps would be taken to
create a single, unified exchange-traded market for corporate bonds.
The measures already taken in respect of implementation of the
recommendations of the Patil Committee include:
• The regulatory jurisdiction of RBI and SEBI with respect to regulation of
corporate bond market has been clarified. SEBI is responsible for
primary and secondary debt market while RBI is responsible for the
market for repo/reverse repo transactions in corporate debt.
• The Securities Contracts (Regulation) Act, 1956 has been amended to
include securitized instruments within the ambit of "securities".
• The RBI Act, 1934 has been amended to empower RBI to develop and
regulate market for Repos in corporate bonds.
• The limit of FIIs investment in corporate bonds has been increased to
USD 20 billion and the incremental limit of USD 5 billion has to be
invested in corporate bonds with residual maturity of over five years
issued by companies in infrastructure sector.
• The trade reporting platform for corporate bonds has been
operationalised since 1st January, 2007.
• SEBI (Issue and Listing of Debt Securities) Regulations, 2008 simplifies
disclosures and listing requirements.
• Repos in corporate bonds have been permitted, following RBI guidelines,
since March 2010.
• The Finance Act, 2008 (with effect from 01/06/2008) mandated that no
TDS (tax deduction at source) would be deducted from any interest
payable on any security issued by a company, where such security is
issued in dematerialised form and is listed on a recognised stock
exchange in India.
• A Working Group on Foreign Investment in India was set up by the
Government in 2009 which submitted its report in 2010 with detailed
recommendations on legal process, qualified foreign investment,
outflows into equity, debt, derivatives and tax.
• To encourage greater private sector participation in the development of
infrastructure in the country, the budget of 2011-12 announced further
liberalisation of the policy relating to the investment in corporate bond
market. For this purpose, FII limit in the corporate bonds, with a residual
maturity of over 5 years and issued by companies in the infrastructure
sector, would be increased by an additional limit of USD 20 billion taking
the total limit to USD 25 billion. With this, the total limit available to FIIs
for investment in corporate bonds would be USD 40 billion. FIIs were
also permited to invest in unlisted bonds.
• In order to further liberalise the portfolio investment route, SEBI
registered Mutual Funds were permited to accept subscriptions for
equity schemes as well as debt schemes in the infrastructure sector from
foreign investors who meet the KYC requirements.
• In order to increase the capital flows, it was decided to:
• increase the current limit of FII investment in Government Securities by
US $ 5 billion raising the cap to US $ 15 billion. The incremental limit of
US $ 5 billion can be invested in securities without any residual maturity
criterion; and
• increase the current limit of FII investment in corporate bonds by US $ 5
billion raising the cap to US $ 20 billion. The incremental limit of US $ 5
billion can be invested in listed corporate bonds.
• In the Budget 2012-13, Government announced its intention to permit
QFIs to invest in corporate bonds in India so as to extend the QFI
framework to all three important segments of the Indian Capital
markets, i.e., Mutual Funds, Equity Market and Corporate Bond Market.
• In view of the increasing capital requirement of the power sector,
Hon'ble Finance Minister had, in his Budget Speech 2012-13, announced
further liberalization of the ECBs for refinancing of the Rupee debt for
the power sector.
• Power companies will now be able to raise ECBs for refinancing their
rupee debt upto a maximum limit of 40 per cent, provided the remaining
60 per cent of the ECB raised is utilized for investment in a new project.
• It was also announced in the same budget that companies in the
aviation sector would be allowed to avail of ECBs for a period of one
year for working capital / refinancing of outstanding working capital
rupee loan(s).
• The ECBs made under this provision would have a maximum ceiling of
USD 1 billion for the entire Civil Aviation sector. The limit for individual
airline companies would be US$ 300 million. This limit can be availed
either in a lump sum or in tranches depending upon the utilisation of the
limit during the 1 year when the facility is available.
• Other initiatives proposed/implemented under the Union Budget of
2013-14 and 2014-15(I) include:
• Government liberalised FDI policy in tele-communication,
pharmaceuticals, civil aviation, power trading exchange, and multi brand
retail to attract large investment.
• ADR/GDR Scheme revamp, an enlargement of the scope of depository
receipt.
• Liberalization of rupee denominated corporate bond market.
• Currency Derivatives Market to be deepened and strengthened to
enable Indian Companies to fully hedge against foreign currency risk.
• To create one record for all financial assets of every individual.
• To enable smoother clearing and settlement for international investors
looking to invest in Indian bonds.
• Swift action taken to sequester National Spot Exchange Limited (NSEL)
after the payment crisis in the NSEL, this prevented spill over of the crisis
to the other regulated segment of the financial markets.
• Proposal to amend the Forward Contracts (Regulation) Act.
• Infrastructure tax-free bonds introduced.
• Proposal to amend the SEBI Act, to strengthen the regulator, under
consideration.
• Number of proposal finalised in consultation with SEBI.
• Designated depository participants, authorised by SEBI, may register
different classes of portfolio investors, subject to compliance with KYC
guidelines.
• SEBI will simplify the procedures and prescribe uniform registration and
other norms for entry for foreign portfolio investors.
• Rule is proposed that, where an investor has a stake of 10 per cent or
less in a company, it will be treated as FII and, where an investor has a
stake of more than 10 per cent, it will be treated as FDI.
• FIIs will be permitted to participate in the exchange traded currency
derivative segment to the extent of their Indian rupee exposure in India.
• FIIs will also be permitted to use their investment in corporate bonds
and Government securities as collateral to meet their margin
requirements.
• SEBI to prescribed requirement for angel investor pools by which they
can be recognised as Category I AIF venture capital funds.
• Small and medium enterprises, to be permitted to list on the SME
exchange without being required to make an initial public offer (IPO).
• Stock exchanges to be allowed to introduce a dedicated debt segment
on the exchange.