The finance ministry and the RBI set up CFSA in September 2006, under a financial sector assessment program of the International Monetary Fund and the World Bank, to undertake complete health check of the Indian financial sector.
While the banks were generally in a position to absorb significant shocks due to credit, liquidity and market risks, there were some concerns relating to liquidity risk due to increasing liquidity in banks balance sheets. There is, therefore, a need to strengthen liquidity management, the report said.
The CFSA report is crucial at a time when the global financial system is facing a worst possible crisis and the strength of Indian financial sector to withstand this crisis is being tested everyday. The Committee has stressed the benefit of having rules-based regulation complimenting the principles-based regulation. The RBI, which has been criticized for not appreciating a principles-based regulation, has acquired fresh intellectual muscle after the failure of such regulation in the UK.
The report endorsed the existence of multiple regulators, though it suggested the need to improve co-ordination among financial sector regulators. The Committee cautioned against institutionalisng the informal information-sharing mechanism among regulatorsthe high level coordination committee on financial markets among regulators.
The CFSA argued capital augmentation at the public sector banks could be challenge in the future, which could be managed through amalgamation among banks, dilution of government stakes, and issuing newer instruments like perpetual preference shares in foreign currency. The CFSA stressed the government should continue its monitoring function of the state-owned banks and the governance should not be left entirely to a duly constituted board.
The report suggested that foreign banks entry into India must be subject to the reciprocity principle, and in case they adopt the subsidiary route, the foreign shareholding should not exceed 74%. Besides, Indian subsidiaries to foreign banks should be listed on local stock exchanges and these banks should be subject to all requirements that local banks are subject to, it said.
The CFSA has recommended a cautious and gradual approach for development of credit derivatives market in the Indian financial sector as well as in opening up the Indian debt market to foreign investment. Acceptance of highly rated corporate paper for repo and reverse repo transactions, better cash management by the government and capacity building for better liquidity forecasting are some of the major steps needed to develop the markets, it said. A focused monitoring of equity market intermediaries and a central integrated platform to streamline issuance procedures has been called for.
The CFSA report concluded, Indias financial sector is generally sound, resilient and fairly liquid. The financial infrastructure is also assessed to be robust. But there are some concerns, such as corporate governance in the co-operative sector, funding constraints of Non-Banking Finance Companies and the lack of up-to-date data to gauge household indebtedness, and serious gaps in the timely implementation of bankruptcy proceedings, the report said.