Financial RegTech Newsletter, January 2022

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Financial RegTech Newsletter

January 2022

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RBI’s ‘Report on Trend and Progress of Banking in India, 2020–2021’

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The annual publication by the Reserve Bank of India (RBI) on the trends and progress of banking in India for 2020–2021, published on 28 December 2021, provides a perspective on the key challenges faced and the progress made by the banking and non-banking sectors in India in the wake of the COVID-19 pandemic.

This edition of the Financial RegTech newsletter provides an overview of the current policy environment. Moreover, the measures taken by the RBI to help the sector stave off these challenges going forward are discussed.

Introduction

The second wave of the COVID-19 pandemic interrupted the slow but steady recovery of the Indian economy in the second half of FY21. In the wake of the pandemic, the RBI made the following policy decisions:

• announcing temporary moratoriums

• implementing credit restructuring frameworks

• providing a fiscal stimulus of about 8.7% of the gross domestic product (GDP)

• infusing liquidity to the order of 8.7% of the GDP

• slashing policy rates by 115 basis points (bps).

The RBI’s unprecedented response to the pandemic controlled its impact on the Indian economy. Job losses were limited, financial markets kept functioning, credit was made available, and supply chain and logistics disruptions were averted owing to the timely policy interventions of the regulator.

RBI’s ‘Report on Trend and Progress of Banking in India, 2020–2021’

Moreover, the RBI gradually started winding down the liquidity infusions made during the pandemic, in the first half of FY22. These reversals included liquidity schemes for mutual funds, dealers and non-banking financial companies (NBFCs). The regulatory cash reserve ratio (CRR) limit, which was reduced by 100 bps during the pandemic, has been restored to the pre-pandemic level.

Furthermore, the RBI made large-scale bond purchases under the Government Securities Acquisition Programme (G-SAP) to rebalance the excess liquidity in the market.

These steps were taken by the RBI to avoid extended impacts to the liquidity of banks, thereby reducing systemic risks to financial stability. The excess liquidity in the system was rebalanced by moving from fixed-rate reverse repo passive absorption to market-based reverse repo auctions for its liquidity adjustment facility (LAF).

However, these re-alignments are being done ensuring adequate liquidity in the system to support growth targets.

This newsletter focuses on the monetary, liquidity and regulatory policies and recent developments in a pandemic-affected changing environment.

Monetary and liquidity policies

The RBI reduced policy rates by 135 bps cumulatively, from February 2019 to February 2020. The policy rate has been cut further to take the overall reduction to 250 bps cumulatively in the current easing cycle. Additionally, the RBI widened the LAF by reducing the reverse repo rate by 155 bps cumulatively to 3.35% in May 2020 during the first wave. This accommodative stance of the RBI

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Financial RegTech Newsletter - January 2022 3 PwC

has been maintained since, in order to stimulate growth and decrease the impact of the pandemic on the Indian economy.

RBI’s ‘Report on Trend and Progress of Banking in India, 2020–2021’

The policy rates have been kept unchanged in all the five meetings of the Monetary Policy Committee (MPC) in the current financial year, FY22. In the April 2021 and

June 2021 meetings, the RBI opined that policy support was essential as the second wave of the COVID-19 pandemic could dampen growth targets. This was despite the fact that rising crude oil prices in May–June 2021 were putting inflationary pressures on the system. However, in its next meeting in August 2021, the MPC held that these inflationary pressures were transitory. Moreover, they were largely driven by unfavourable supply side shocks.

Therefore, the policy rates remained unchanged. The policy rates were also kept unchanged in the

October 2021 meeting as the MPC observed that the

• The RBI is gradually realigning the liquidity infusion and other support policies taken during the first wave of the pandemic to ensure financial stability. Liquidity to the order of 2%

of the GDP was drawn to a close in the first half of FY22.

• At the same time, the RBI has brought in reforms such as scale-based regulation of NBFCs to support growth. Revised guidelines on credit default swaps and securitisation have also been announced.

aggregate demand was still below pre-COVID levels, even though it was improving progressively. The rates were kept on hold in the December 2021 MPC meeting as well due to the unpredictability created by the emergence of new COVID mutations.

Complementing the accommodative stance since the first wave, the RBI maintained surplus liquidity in the banking system through its LAF policy. The net daily absorption under this facility averaged INR 4.96 lakh crore for FY21 and INR 6.69 lakh crore for FY22 (up to 22 December 2021). A liquidity injection of about INR 2.29 lakh crore was made through open market operations (OMOs) in FY22, in addition to an infusion of about INR 3 lakh crore through OMOs in FY21.

The RBI conducted 19 Operational Twist (OT) auctions in March 2021. Another three auctions have been conducted in FY22 so far. Purchase and sale of Government securities worth INR 40,000 crore and INR 35,000 happened in the OTs of March 2021 and FY22 (up to 22 December 2021), respectively.

Furthermore, the RBI announced liquidity measures targeted at specific sectors affected by the pandemic. The targeted long-term repo operations (TLTRO) scheme for banks was announced at the onset of the pandemic. Under this scheme, repurchase agreements of up to three years were made with banks, at a floating rate linked to the policy repo rate through auctions. Funds availed by banks under this scheme had to be placed in investment grade corporate bonds, non- convertible debentures (NCDs) and commercial papers to provide financial stability. This scheme was enhanced with the addition of TLTRO 2.0 and on-tap TLTROs. TLTRO 2.0 auctions were conducted at the policy repo rate targeted at

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RBI’s ‘Report on Trend and Progress of Banking in India, 2020–2021’

NBFCs, microfinance institutions (MFIs) and micro, small and medium enterprises (MSMEs). Moreover, in October 2020, banks were issued on-tap TLTROs up to three years at the policy repo rate to be deployed to debt issued by entities in specific stressed sectors. These sectors include agriculture, agri-infrastructure, pharma, healthcare and more than 25 other sectors.

However, amidst the above liquidity measures, the RBI decided to gradually normalise liquidity operations from January 2021. Five variable rate reverse repo (VRRR) auctions were conducted from January to March 2021 in this regard. Rebalancing of excess liquidity in the system through VRRRs and fixed rate repos under the LAF has been a key policy aspect in FY22. The size of these reverse repo operations was elevated in a phased manner.

This was done by taking into consideration the market feedback at each phase.

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RBI’s ‘Report on Trend and Progress of Banking in India, 2020–2021’

Note: All figures are in INR crore.

Source: RBI’s Report on Trends and Progress of Banking in India, 2020–2021 Special refinancing facilities in FY21 and FY22

AIFIs April-2020 May-2020 August-2020 April-2021 June-2021 Total

NABARD 25,000 - 5,000 25,000 - 55,000

NHB 10,000 - 5,000 10,000 - 25,000

SIDBI 15,000 - - 15,000 16,000 46,000

EXIM Bank - 15,000 - - - 15,000

Total 50,000 15,000 10,000 50,000 16,000 141,000

Abbreviations: AIFIs – All-India Financial Institutions, NABARD- National Bank for Agriculture and Rural Development, NHB- National Housing Bank, SIDBI- Small Industries Development Bank of India, EXIM Bank- Export Import Bank of India.

The RBI provided special refinancing facilities at lower rates to All India Financial Institutions (AIFIs). Refinancing amounting to INR 75,000 crore was provided to AIFIs in FY21. Furthermore, a sum of INR 66,000 crore of fresh funding was provided to AIFIs to meet their credit requirements during FY22. The details of the refinancing provision are as given in the table below:

RBI’s ‘Report on Trend and Progress of Banking in

India, 2020–2021’

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Regulatory policies and recent developments

Responding to the pandemic situation, the RBI announced a slew of regulatory support measures such as moratoriums on loans, special frameworks for restructuring, a temporary halt on asset classification, dividend payout restrictions and zero-risk weights on certain credit facilities guaranteed by government- backed credit schemes. At the same time, the RBI made specific regulations for the different categories of financial institutions in India.

Regulatory policies for scheduled commercial banks (SCBs)

• Under Resolution Framework 1.0 introduced in August 2020, the RBI allowed implementation of a resolution plan for corporate borrowers and personal loans. Under

• The RBI kept the policy repo rate unchanged in FY22, maintaining an accommodative stance, which will continue till growth parameters reach pre-COVID levels.

• Surplus liquidity infusion has been made by the RBI with the help of LAF and TLTROs to ensure sustained growth during the pandemic period.

However, the RBI has started removing some of the excess liquidity from the system in FY22 via VRRRs.

this plan, loans were classified as standard till the time of resolution invocation, provided the borrower was not more than 30 days past due on any other loan as of 1 March 2020. The plan had to be executed within 90 and 180 days for personal and other loans, respectively, from the date of invocation. Allowances made as part of the plan included rescheduling of payments, transfer of accrued interest into another facility, sale of loan to other entities and change in ownership and restructuring.

• Resolution Framework 2.0 was introduced in May 2021, extending the plan to individuals, small borrowers and MSMEs. The RBI mandated that the resolution plan under framework 2.0 must be implemented within 90 days from the plan invocation date.

• For MSME and individual borrowers with borrowings up to INR 2 crore, the Government announced a scheme to repay the difference between the compounded and simple interest accrued during the moratorium period.

• The loan-to-value (LTV) of loans against gold was

temporarily increased for non-agricultural purposes from 75–90% in August 2020. This was done to provide a buffer to small businesses and households during the pandemic. This provision was made applicable till 31 March 2021.

• The RBI directed banks not to make any dividend payments on outstanding shares from the profits of FY2020. This was done to conserve funds and support credit delivery.

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RBI’s ‘Report on Trend and Progress of Banking in India, 2020–2021’

• The regulatory CRR, which was reduced to 3% of net demand and time liabilities (NDTL) at the onset of the pandemic, was increased to 3.5% in March 2021 and restored to the pre-pandemic level of 4% of NDTL in May 2022. This resulted in increased reserves available with banks as a buffer against credit losses.

• Banks were permitted to invest in statutory liquidity ratio (SLR) securities under the held-to-maturity (HTM) category up to the revised HTM limit of 22% of NDTL.

Moreover, the HTM investment ceiling in SLR securities was revised from 19.5% to 22% of NDTL till March 2023, for securities purchased between September 2020 and March 2022.

• The implementation of the last tranche of the capital conservation buffer (CCB) of 0.625% and the net stable funding ratio (NSFR) guidelines was deferred till 1 October 2021.

• The aggregate limit to qualify as retail exposure (individuals and small businesses) was increased from INR 5 crore to INR 7.5 crore, to increase credit flow to the retail segment. The lower risk weight of 75%

assigned to this segment meant a reduced credit cost as well as increased lending. Similarly, the risk weights for individual housing loans were rationalised to provide an incentive to housing finance. The LTV limit was increased to 90%, and the risk weights for the same were rationalised at 50%.

• The Central Know-Your-Customer Registry (CKYCR), which is now fully functional for individuals, has been extended to legal entities for accounts opened after April 2021.

• Revised guidelines on enhancing standards of security and safety of deposit lockers and release of locker contents and alerts to customers through SMS/email have been announced by the RBI. The liability of banks in the case of employee fraud pertaining to locker contents has also been increased.

Regulatory policies for co-operative banks

• The RBI had limited authority to regulate co-operative banks as per the Banking Regulations (BR) Act of 1949.

This act was amended in 2020 to provide more power to the RBI to regulate co-operative banks and improve their overall governance framework for the benefit of depositors.

• Post the amendments made in the BR, the RBI was provided the power to approve the mergers or amalgamations of urban co-operative banks on its own;

this was not the case previously.

Regulatory policies for NBFCs

• The RBI announced a scale-based regulatory framework for NBFCs in October 2021. This framework categorises all NBFCs into one of the following four layers – base layer, middle layer, upper layer and top layer, based on their asset sizes. The asset-size limit for categorisation increases from the base to the top layer. The objective of the framework is to increase regulations progressively from the base to the top layer, so that the smaller

NBFCs are not burdened with unnecessary regulations but governance standards are improved at larger NBFCs at the same time.

RBI’s ‘Report on Trend and Progress of Banking in

India, 2020–2021’

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RBI’s ‘Report on Trend and Progress of Banking in India, 2020–2021’

• The secured debt limit for recovery under the

Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act was reduced from INR 50 lakh in 2020 to INR 20 lakh in February 2021 to improve recoveries from MSMEs.

Other recent developments

• The Prompt Corrective Action (PCA) framework of the RBI for the proactive monitoring of SCBs was revised in January 2022 to remove the negative return-on- assets (ROA) trigger from the list of PCA initiation triggers. Furthermore, a PCA framework for NBFCs was introduced in December 2021; it will come into effect from October 2022 based on the FY22 results. Capital adequacy, net asset quality and leverage would be some key parameters that would be tracked.

• A dedicated entity, National Asset Reconstruction Company Limited (NARCL), was introduced in July 2021 for the aggregation of bad loans from all banks to ensure faster resolution and better recoveries. The initial focus of NARCL will be legacy non-performing assets (NPAs) and an outstanding debt of INR 500 crore and above, totalling to about INR 2 lakh crore.

Financial markets, foreign exchange and financial inclusion

• The RBI advised banks and other regulated entities in July 2021 to make a planned transition away from the London Interbank Offered Rate (LIBOR) to any alternative reference rate (ARR) that is widely accepted.

This advisory was made due to cases of manipulation of the global market reference rates and decrease in the interbank transactions, post the financial crisis of 2008.

• The RBI announced several regulatory measures for SCBs such as the resolution framework, reduction in regulatory CRR and revisions in risk weights of assets to help them respond to the pandemic better.

• For NBFCs, the RBI introduced a scale-based approach to regulate differentially, based on the asset size. Moreover, NBFCs have been provided more power to recover loans under the SARFAESI Act.

• The PCA framework was introduced by the RBI to proactively monitor banks and NBFCs, and avoid any spillover risks in stressful times such as the COVID-19 pandemic.

• Money market regulations have been reviewed to grow the market and introduce more standards. Regional rural banks have been permitted to participate in money markets and issue certificates of deposit (CDs). Issuers of CDs have been allowed to buy them back before maturity to provide a greater buffer in terms of liquidity.

• The maximum period for borrowers to park unused external commercial borrowings (ECB) funds raised before March 2020 in term deposits of Authorised Dealer (AD) Category I banks was temporarily extended to 24 months. This change was made from the current 12 months as a relief measure during the pandemic.

RBI’s ‘Report on Trend and Progress of Banking in

India, 2020–2021’

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• The RBI performed a review of the reporting

requirements under the Foreign Exchange Management Act, 1999. Out of the existing 67 returns, 17 were discontinued from November 2020, considering the latest technological developments. This would help reduce compliance cost of reporting institutions.

• As of FY21 end, 95% of rural banking branches in India were operated by business correspondents (BCs).

The RBI introduced a BC certification course, known as ‘Train the trainers’ programme, to educate bank officials. Moreover, a registry portal with BC details was introduced to improve delivery of financial services in rural areas.

• The RBI established a grievance redressal framework in January 2021 to improve customer service at banks.

The framework includes enhanced disclosures of consumer grievances, penalties for banks – if the costs of grievance redressal exceed a certain threshold – and continuous reviews.

RBI’s ‘Report on Trend and Progress of Banking in India, 2020–2021’

• The RBI has directed banks to move away from LIBOR to bring in more transparency in inter- bank transactions.

• The RBI is focusing on improving the BC model and grievance redressal mechanisms to ensure better financial inclusion.

• The RBI is encouraging increased use of digital payments and contactless transactions by creating conducive infrastructure for payment service providers to offer innovative products to customers.

• Affordability, security and interoperability are key considerations for the RBI in this regard.

Payments ecosystem

• In May 2021, the RBI made the use of prepaid payment instruments (PPIs) mandatory. It increased the maximum allowable balance in PPIs to INR 2 lakh and permitted customers to withdraw cash using full-KYC PPIs.

• Considering the pandemic and growing significance of contactless transactions, the RBI increased the per transaction limit of NFC-enabled contactless card transactions from INR 2,000 to INR 5,000 in January 2021.

• The RBI allowed authorised payment service providers (PPIs, card networks) access to centralised payment systems (NEFT and RTGS) to improve the overall digital payments infrastructure.

• The RBI has established the Reserve Bank Innovation Hub as a subsidiary company to facilitate smooth collaboration of stakeholders in the banking, start-up, and regulatory sectors to promote innovation in the financial technology space.

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RBI’s ‘Report on Trend and Progress of Banking in India, 2020–2021’

Conclusion

The COVID-19 pandemic has disrupted the Indian economy, created stress in businesses and impacted households. The RBI has tried to mitigate these risks by taking prompt monetary, liquidity and regulatory measures.

The RBI injected surplus liquidity into the system at the beginning of the pandemic. Although supply-side shocks were hampering the market, the RBI tried to provide a buffer to stressed sectors and keep finance flowing. As the economy revived post the lifting of lockdowns in the first wave of the pandemic, the focus of the RBI was on rebalancing excess liquidity. This had to be done while building adequate buffers at the same time, keeping in mind the constantly developing risks. Higher provisioning and moratoriums on loans were some of the regulatory announcements made by the RBI to achieve its objective.

The primary challenge for the RBI, though, was to maintain a balance between ensuring short-term liquidity at banks and providing regulatory support to stressed borrowers. Going forward, the RBI will have to continue to manage evolving risks proactively and set up governance mechanisms to ensure credit growth and support the reviving economy.

The pandemic has highlighted the importance of

technology in the banking and financial services industry.

Therefore, the RBI needs to be aware of the opportunities and challenges that come with technological progress, to create an inclusive and safe financial services ecosystem for all stakeholders.

RBI’s ‘Report on Trend and Progress of Banking in

India, 2020–2021’

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Regulatory news

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Financial RegTech Newsletter - January 2022

RBI hikes threshold for deposits of non-financial small business customers

The RBI has amended the threshold limit for deposits and other extensions of funds made by non-financial small business customers from INR 5 crore to INR 7.5 crore to maintain the liquidity coverage ratio (LCR).

The detailed notification can be accessed here.

RBI to allow banks to infuse

capital in overseas branches and subsidiaries

Banks will be allowed to add capital in overseas branches and subsidiaries and retain and transfer profits from these subsidiary, branches without any prior approval from the RBI. However, this will be subject to meeting required regulatory requirements. This decision is taken with a view to facilitate operational flexibility of banks.

Presently, before infusing any capital, and retaining or transferring profits from overseas subsidiaries, banks need prior approval from the regulator.

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RBI allows transition from LIBOR to ARR

To simplify the transition from LIBOR-linked foreign currency (FCY) ECB/trade credit (TC) to relevant benchmark rates, the RBI has allowed the use of the widely accepted ARR as a benchmark, post the discontinuation of LIBOR.

The RBI has also revised the all-in-cost ceiling by 50 bps to factor in the differences in credit risk and term premia between LIBOR and the ARRs. The all-in-cost ceiling for new ECBs and TCs has been increased to 500 bps and 300 bps, respectively.

RBI to launch UPI product for feature phone users and increase UPI transaction limits

The Unified Payments Interface (UPI) has become the largest payment mechanism in India. Currently, this mechanism requires internet-enabled phones to send or receive money. In India, there are 45 crore feature phone users, which constitute approximately 38% of mobile users. To strengthen wider digitalisation and deepen financial penetration, it is imperative to include feature phone users in digital payment mechanisms.

Regulatory news

To accelerate the retail customer participation in primary and secondary markets, G-sec and initial public offering (IPO), the RBI has increased transaction limit through UPI to INR 5 lakh from current limit of INR 2 lakh.

PCA framework for NBFCs

The RBI has introduced the PCA framework for NBFCs, considering their growing size and interconnectedness with other segments of the financial system. These measures will bring NBFCs under the same umbrella as commercial banks in terms of supervision and regulatory reach.

The PCA framework will be applicable to all deposit-taking and non-deposit taking NBFCs in the middle, upper and top layers. However, non-deposit taking NBFCs with asset sizes less than INR 1,000 crore, government companies, primary dealers and housing finance companies are excluded from this framework.

The main objective of the framework is to allow timely supervisory intervention and take necessary measures to minimise the impact and restore financial health of banks and NBFCs.

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SEBI modifies exercise mechanism of options on commodity futures

The capital market regulator, the Securities and Exchange Board of India (SEBI), modified the exercise mechanism of options on commodity futures. The decision was taken after receiving feedback from stock exchanges.

As per the circular, in the modified mechanism, all the in- the-money (ITM) options will be exercised automatically unless ‘contrary instruction’ has been given by long position holders. Nevertheless, the out-of-the-money (OTM) option will expire. Moreover, all the exercised contacts within the series will be mapped to short positions without any preferential treatment.

The new mechanism shall be effective from the date of new series of commodity derivates launched on or after 1 February 2022.

SEBI issues framework for operationalising gold exchange

SEBI has finalised a framework wherein trading in yellow metal gold will be allowed in the form of electronic receipts (EGRs). Desirous stock exchanges need to take necessary approvals from the regulator to facilitate trading in new segment.

As per the circular, the transaction is divided into three parts: (1) conversion of physical gold into EGRs, (2) trading of EGRs on stock exchanges and (3) conversion of EGR into physical gold.

Stock exchanges have been allowed to launch gold contracts in different denominations for either type of the transactions.

Market regulator has introduced fungibility and

interoperability between vault managers. As per SEBI’s definition of fungibility, the EGRs created by the vault managers shall not be linked with the unique bar reference number of the physical gold. In addition, interoperability between vault managers will allow investors to withdraw physical gold from different locations having the same or different vault manager.

SEBI constitutes ‘Advisory

Committee for Leveraging Regulatory and Technology Solutions’ (ALeRTS)

SEBI has set up an advisory committee to enhance regulators’ technological capabilities and explore more advanced solutions to detect early market anomalies.

The Advisory Committee for Leveraging Regulatory and Technology Solutions (ALeRTS) will be headed by SEBI’s former whole time member, Madhabi Puri Buch. The committee will also include other various industry experts.

The terms of reference of the committee include

recommending future roadmaps and developments in the various ongoing technology projects and guiding SEBI in designing different inhouse systems. Apart from this, the committee will also guide SEBI in finding optimal technology solutions with respect to different domains.

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Global regulatory news

FCA to register the first UK securitisation repositories

The Financial Conduct Authority (FCA) has decided to register both entities, European DataWarehouse Ltd and SecR, as securitisation repositories (SRs) under the UK Securitisation.

EBA to introduce central database to counter money laundering and financing of terrorism

The European Banking Authority (EBA) published a draft of regulatory technical standards (RTS) on a central database on anti-money laundering and countering the financing of terrorism (AML/CFT) in European Union.

The database named ‘EuReCa’ will contain information with respect to vulnerabilities faced by different financial institutions. As a result, it will expose them to money laundering and terrorism financing (ML/TF). The competent authorities will have to report such vulnerabilities, as well as the steps taken to rectify them.

EuReCa will be used as an early warning tool, which will help the EBA to analyse how the ML/TF risk affects the EU’s financial sector. Moreover, EuReCa will help to strengthen anti-money laundering/combating the financing of terrorism (AML/CFT) supervision and prevent and counter ML/TF in the EU.

EBA claims asset quality rises;

banks still concerned about cyber risks

The European Banking Authority (EBA) has reported that asset quality of banks has improved as the non-performing loan (NPL) ratio declined to 2.1%, and the stage 2 ratio contracted to 8.7%. Return on equity (RoE) was higher than the pre-pandemic levels at 7.7%.

The decline in NPL was driven by a decrease in non- performing loan to EUR 419 billion. However, sectors exposed to COVID-related restrictions continue to carry higher NPL.

As per the report, 55% of banks expect operational risks to be increased. Of these, 90% banks consider cyber and data security risks as core reasons for the increase in operational risks.

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Mukesh Deshpande

Partner, Technology Consulting PwC India

[email protected] +91 – 98450 95391

Hardik Gandhi

Director, Technology Consulting PwC India

[email protected] +91 – 9819379703 Arvind Raj

Principal Consultant, Technology Consulting PwC India

[email protected] +91 - 9969358788 Umang Agrawal

Associate Director, Technology Consulting PwC India

[email protected] +91 - 9769195355

Anurag Gupta

Principal Consultant, Technology Consulting PwC India

[email protected] +91 – 7760314901

Contact us

This newsletter has been researched and authored by Anand Raghunathan, Dharmit Jhunjhunwala and Keerti Gogna.

Acknowledgements

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Financial RegTech Newsletter, January 2022