January 2020 - PwC · and the RBI.4 The Registrar of Cooperative Societies is responsible for...
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Financial RegTech Newsletter January 2020
Transcript of January 2020 - PwC · and the RBI.4 The Registrar of Cooperative Societies is responsible for...
Financial RegTech NewsletterJanuary 2020
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Amendments to the Banking Regulations Act, 1949 For the past few years, the banking sector has been struggling with degrading asset quality. Gross non-performing assets (NPAs) of scheduled urban cooperative banks (UCBs), as a percentage of gross advances, increased from 6.4% in March 2019 to 10.5% in September 2019. The liquidity crunch set off by the debt default of Infrastructure Leasing & Financial Services (IL&FS) has affected the confidence of the entire banking industry. The incident of fraud in the Punjab & Maharashtra Co-operative Bank Limited (PMC) is one of the many instances of fraud in cooperative banks. As per official reports, there have been 1,000 cases of frauds worth INR 220 crore in UCBs in the last five years.1 The PMC fraud was a clear case of misconduct on part of the board-level executives of the bank, as huge exposure to a single entity in the real estate sector was disguised into several dummy accounts. Taking cue from the recent PMC bank crisis and to bring back depositors’ confidence in the cooperative banking system, the Union Cabinet has approved amendments to the Banking Regulation Act, 1949, owing to which the Reserve Bank of India (RBI) will have more control over UCBs.
RBI gains more control over urban cooperative banks
1. https://www.businesstoday.in/sectors/banks/urban-cooperative-banks-hit-by-1000-frauds-worth-over-rs-220-crore-in-past-5-fiscals-rbi/story/394714.html
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Why the focus on UCBsUCBs have INR 4.84 lakh crore in deposits and have given advances worth INR 3 lakh crore to its members.2 Cooperative banks play a significant role in providing credit to the under-banked segments of the population and especially to the ones who are at the lower end of the income pyramid. UCBs are responsible for providing credit at affordable rates in urban and semi-urban areas while rural cooperatives provide financial services in villages. UCBs are of systemic importance as many small cooperative banks have accounts in large UCBs which provide higher rates of return on their deposits. This makes it important to safeguard the interest of depositors in such institutions.
RBI gains more control over urban cooperative banks
2. https://dbie.rbi.org.in/DBIE/dbie.rbi?site=publications#!133. https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11381&Mode=04. https://www.rbi.org.in/scripts/NotificationUser.aspx?Id=11774&Mode=0
Current supervisory regime In November 2018, the RBI came up with guidelines allowing UCBs to voluntarily transition into small finance banks (SFBs), which would be under complete control of the RBI, thus ending the challenge of dual regulation.3 However, these guidelines failed to gain traction as UCBs saw no advantage in following them and operating as a small finance bank would result in the loss of their cooperative nature.
At present, cooperative banks are governed through dual regulations of both the Registrar of Cooperative Societies and the RBI.4 The Registrar of Cooperative Societies is responsible for incorporation, registration, management, audit, supersession of board and liquidation, while the RBI is responsible for maintaining cash reserves and capital adequacy, amongst others. Post the amendments getting cleared by the Parliament, cooperative banks will be audited as per the RBI’s norms and appointing chief executives will require permission from the banking regulator. However, the Registrar of Cooperative Societies will continue to play its administrative role.
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Challenges with cooperative banksCooperative banking has been mired in controversies as there have been several instances of frauds involving large amounts of money and subsequently resulting in a cooperative bank’s liquidation by the RBI. The fraud committed by Harshad Mehta in 1992 sank the Metropolitan Cooperative Bank and the stock market scam of 2001 by Ketan Parekh resulted in the closure of the Madhavpura Mercantile Cooperative Bank.
All these cases indicate the failure or absence of internal control and systems in cooperative banks. It is a general observation that there is political influence in boards of cooperative banks which often proves to be a hindrance to their professional activities.
Weak corporate governance has always been a big issue with the cooperative banking space. Dual regulation, lack of professionalism, slower adoption of new technology and inadequate checks and balances at cooperative banks are to be blamed for regulatory failure of cooperative banks.
RBI gains more control over urban cooperative banks
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How the RBI is trying to helpLack of effective regulation of the cooperative banking space has resulted in a demand for increased control of the RBI over cooperative banks. It is imperative to deploy a mechanism that addresses the problem of dual control and streamlines the regulatory and supervisory approach. Cooperative banks could benefit from the RBI’s proven governance mechanism which would improve the quality of governance in UCBs, thus ensuring their smooth and competent functioning.
For better governance in the cooperative banking space, the RBI has taken the following measures:
1. In order to better manage UCBs, the RBI has come up with a Supervisory Action Framework (SAF), according to which a UCB will be placed under the SAF if it faces any one of the situations mentioned below.5 The SAF will help in expeditious resolution of UCBs experiencing financial stress if:• any UCB’s net NPA exceeds 6% of its net
advances, depending on the severity of stress• a UCB has incurred losses for two consecutive
years or has accumulated losses in its balance sheet, depending on the severity of stress
• a UCB’s capital to risk assets ratio (CRAR) is below 9%, depending on the severity of stress.
2. The RBI has issued a directive for the constitution of a board of management in UCBs with a deposit size of INR 100 crore and above.6 It also directed such banks to take approval from the RBI for appointing their chief executive officers (CEOs).
3. The RBI has asked UCBs having total assets of more than INR 500 crore reported in the previous financial year to record credit information, including asset classification of borrowers having exposure greater than INR 5 crore, in the Central Repository of Information on Large Credits (CRILC), every quarter.7 The RBI also expects UCBs to have proper systems in place to submit the return at a lower frequency.
4. In its annual report of 2018–19, the RBI came up with the idea of creating an umbrella organisation which will provide liquidity and capital support to cooperative banks.8 UCBs can neither raise capital through public issue or through issue of shares at a premium.
An umbrella organisation will provide support to the member banks and is expected to create information technology (IT) infrastructure facilities for shared use by members at a reduced cost.
5. https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11779&Mode=06. https://www.rbi.org.in/scripts/NotificationUser.aspx?Id=11774&Mode=07. https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11768&Mode=08. https://rbidocs.rbi.org.in/rdocs/AnnualReport/PDFs/0ANNUALREPORT2018193CB8CB2D3DEE4EFA8D6F0F6BD624CEDE.PDF
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What to expect next?In the recent past the RBI has set guidelines for better governance measures for non-banking financial companies (NBFCs). On similar lines, one can expect that the RBI’s measures would require UCBs to create a platform which supports system-driven reporting to the RBI. The RBI prefers system-driven reporting as it enables reporting consistency, data quality and easy auditability of reported data. Also, with reorganisation of the department of regulation (banking, non-banking and cooperative banks) and the department of supervision (banking, non-banking and cooperative banks) into a unified department of supervision and regulation, one can expect rationalisation of returns across all the three entities, viz. banking, non-banking and cooperative banks.
Larger UCBs can look to invest in their own IT infrastructure to enable system-based reporting and address data quality and consistency issues.
Smaller UCBs can work towards creating a shared data and reporting platform. The proposed common platform could be used for reporting to the RBI by cooperative banks which do not have the adequate IT infrastructure to support system-based reporting. The regulator would be able to access data directly from a single source rather than connecting separately with numerous cooperative banks which may or may not have such reporting capabilities. This reporting capability of the IT infrastructure can be provided as software as a service (SaaS).
These measures, if implemented and monitored prudently, will help in strengthening internal control around cooperative banks, making them less vulnerable and proficient enough to ward off frauds, thus reinstating depositors’ confidence and ensuring smooth functioning of the cooperative banking system.
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Cash withdrawal using Point of Sale (PoS) terminalsThe RBI has mandated that banks need to seek one-time permission from the RBI to deploy cash withdrawal facility at Point of Sale (PoS) terminals.
It has also advised the designated merchant establishments to clearly show the availability of this facility, along with the charges incurred by the customer, if any.
The detailed notification, can be accessed here.
Lending against security of single product – Gold jewelleryThe RBI has decided that NBFCs can bring gold jewellery from different branches in a district and can auction from any location within that district, if the first auction has failed. And they must make sure that other requirements related to auction such as prior notice, reserve price, arms-length relationship and disclosures are met.
The detailed notification can be accessed here.
Investment by Foreign Portfolio Investors (FPI) in DebtThe RBI has brought in certain amendments with respect to foreign portfolio investors (FPI). The short-term investment limit by an FPI has been increased from 20% to 30% in central government securities (including treasury bills) or state development loans and corporate bonds.
FPI investments in debt instruments issued either through asset reconstruction companies or an entity under the Corporate Insolvency Resolution Process (CIRP) as per the resolution plan approved by the National Company Law Tribunal (NCLT) under the Insolvency and Bankruptcy Code, 2016, along with security receipts, are exempted from the short-term investment limit.
The detailed notification can be accessed here.
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Implementation of Section 51A of Unlawful Activities Prevention Act (UAPA), 1967- Updates to ISIL (Da’esh) & Al-Qaida Sanctions ListThe RBI has directed that regulated entities (REs) must ensure that they do not have any account in the name of individuals/entities appearing in the lists of individuals and entities suspected of having terrorist links, which are approved by and periodically circulated by the United Nations Security Council (UNSC).
On this point, the Ministry of External Affairs (MEA) has released lists of individuals and entities linked to ISIL (Da’esh), Al-Qaida and Taliban. The updated list has been mentioned in the UNSC release.
The detailed notification can be accessed here.
Amendment to Master Direction (MD) on KYCThe RBI has advised to bring digital channels for customer identification processes by REs. It has permitted Video based Customer Identification Process (V-CIP) as a consent based alternate method of establishing the customer’s identity for customer onboarding. The subsequent changes are carried out in the Master Direction on KYC.
This circular talks about changes due to amendments to the Prevention of Money-laundering (Maintenance of Records) Rules, 2005 (PML Rules), changes due to introduction of Video based Customer Identification Process (V-CIP), etc.
The detailed notification can be accessed here.
Introduction of Rupee derivatives at International Financial Services Centres (IFSC)The RBI has allowed Rupee derivatives (with settlement in foreign currency) to be traded in International Financial Services Centres (IFSCs), starting with Exchange Traded Currency Derivatives (ETCD).
Currency futures contracts and currency options contracts might be listed on recognised stock exchanges at IFSCs, subject to the Currency Futures in International Financial Services Centre (Reserve Bank) Directions, 2020.
This circular discusses notifications related to Currency Futures in International Financial Services Centre, Currency Options in International Financial Services Centre, Foreign Exchange Management (International Financial Services Centre), Currency Futures (Reserve Bank), Exchange Traded Currency Options (Reserve Bank), etc.
The detailed notification can be accessed here.
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Options in Goods - Product Design and Risk Management FrameworkSEBI has allowed Stock Exchanges to launch ‘Option in Goods’ in their commodity derivatives segment. It has prescribed guidelines for the product design and risk management framework. Exchanges which have opted for trading in options contracts with goods need to take approval from SEBI before launching them.
Exchanges should disclose open interest of top 10 largest participants/group of participants in “option in goods” (both long and short) and the details of their combined open interest in underlying constituents etc.
The detailed notification can be accessed here.
Annual System Audit of Market Infrastructure InstitutionsAfter discussing with Stock Exchanges, Clearing Corporations, Depositories (referred as ‘Market Infrastructure Institutions – MIIs) and Technical Advisory Committee (TAC) of the Securities and Exchange Board of India (SEBI), SEBI has recommended to review the existing System Audit Framework.
SEBI has advised MIIs to follow the prescribed framework as well as Terms of Reference (TOR) in order to perform Annual System Audit. MIIs are required to submit Non-Compliances (NCs)/minor NCs observed in the System Audit as per the prescribed format.
Within a month of completion of the audit, MIIs should provide the System Audit report to SEBI, along with the comments of the Management of the MIIs. MIIs are also required to submit a declaration from the MD/CEO certifying the security and integrity of their IT systems.
The detailed notification can be accessed here.
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Review of Margin Framework for Commodity Derivatives SegmentIn order to provide variation of liquidity and volatility among the commodity derivatives, SEBI has decided to categorise commodities as their realised volatility. Floor value of Initial Margin (IM) and Margin Period of Risk (MPOR) will be prescribed based on the categories.
Clearing Corporations (CCs) should categorise their commodities in three categories of volatility based on their realised volatility for past three years.
Volatility Category of Commodity
Realized Annualized Volatility criteria
Low 0 to 15%
Medium Above 15% to 20%
High Above 20%
CCs shall also disclose detailed break up of various applicable margins on contracts cleared by them along with volatility on their websites.
The detailed notification can be accessed here.
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Central bank group to assess potential cases for central bank digital currenciesIn collaboration with the Bank for International Settlements (BIS), the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, the Sveriges Riks Bank and the Swiss National Bank have started a group to share assessments of the potential cases for central bank digital currency (CBDC) in their home jurisdictions.
This group is going to assess several CBDC use cases; economic, functional and technical design choices, including cross-border interoperability; and will impart knowledge on emerging technologies. It will liaise with the relevant institutions and forums, especially the Financial Stability Board and the Committee on Payments and Market Infrastructures (CPMI).
The detailed notification can be accessed here.
ECB’s subscribed capital to remain steady after Bank of England leaves the European System of Central BanksThe subscribed capital of the European Central Bank (ECB) would remain at €10.8 billion after the exit of the Bank of England from the European System of Central Banks (ESCB). Currently, the Bank of England has 14.3% shares in the ECB’s subscribed capital. It would
be divided among both the euro area national central banks (NCBs) and the remaining non-euro area NCBs.
The reallocation among the other NCBs will be done based on the updated key for subscription to the ECB’s capital. There will be recalculation of the weightages of each Member State, based on its share in the total population and gross domestic product (GDP) of the European Union after the UK leaves the European Union.
The detailed notification can be accessed here.
ESMA clarifies SFTR reporting The European Securities and Markets Authority (ESMA) has published the guidelines on reporting under the Securities Financing Transactions Regulation (SFTR), along with amended SFTR validation rules which are in line with updated XML schemas. It has given suggestions on the implementation of different areas such as the number of reportable SFTs, population of reporting fields for margin data, etc.
It has also released a statement on Legal Entity Identifiers (LEI). It clears the expectations in case of LEI reporting used in SFTs for issuers of securities and supervisory actions to be taken by the authorities.
Along with, that it has published the final report which holds detailed assessment of the feedback received from stakeholders on key elements of ESMA guidelines for SFTR reporting.
The detailed notification can be accessed here.
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This newsletter has been researched and authored by Ayush Sahay and D Kalyani.
Vivek BelgaviPartner, Technology ConsultingPwC [email protected]+91 9820280199
Anurag GuptaPrincipal Consultant, Technology ConsultingPwC [email protected]+91 7760314901
Vishal MotwaniDirector, Technology Consulting PwC [email protected]+91 7506800901
Sayan MaitiPrincipal Consultant, Technology ConsultingPwC [email protected]+91 7411019947
Hardik Gandhi Associate Director, Technology ConsultingPwC [email protected]+91 9819379703
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