No.

Minimum standards

Indian position

Remarks

I. General principles governing the supervision of banks' foreign establishments

i.

Effective supervision between host and parent authorities is a central prerequisite for the supervision of banks' international operations. In relation to the supervision of banks' foreign establishments there are two basic principles which are fundamental to such cooperation and which call for consultation and contacts between respective host and parent authorities;

Firstly, that no foreign banking establishment should escape supervision; and

All foreign banking establishments in the country are subject to supervision.

Secondly, that the supervision should be adequate.

Systems are in place and have so far proved to be adequate. In the changing world-wide scenario of banking particularly the integration of markets, there is now a need to strengthen the system further. The first step would be a greater interaction with controlling office (not only the immediately superior office) and the home office regulator. A full understanding of the overall operations of the bank involved is considered necessary.

In giving effect to these principles, host authorities should ensure that parent authorities are informed immediately of any serious problems which arise in a parent bank's foreign establishment. Similarly, parent authorities should inform host authorities when problems arise in a parent bank which are likely to affect the bank's foreign establishment.

This principle has as yet not received universal acceptance amongst regulators in regard to their cross border regulatory obligations. Host authorities in a large majority of cases remain inadequately informed about the parent bank's current and impending difficulties. A more comprehensive system of information sharing based on mutuality and reciprocity need to be established.

II. Aspects of the supervision of banks' foreign establishments

1. Solvency

The allocation of responsibilities for the supervision of the solvency of banks' foreign establishments between parent and host authorities will depend upon the type of establishment concerned.

Supervision of banks in India mainly aims at ensuring the solvency of the banks and their ability to meet their liabilities as and when they arise.

For branches, their solvency is indistinguishable from that of the parent bank as a whole. So, while there is a general responsibility on the host authority to monitor the financial soundness of foreign branches, supervision of solvency is primarily a matter for the parent authority.

While supervising the branches of foreign banks operating in India, RBI looks mainly at the solvency of the branch.

The solvency of the parent bank needs to receive a more pointed attention even if the responsibility to monitor is only general.

For subsidiaries, the supervision is a joint responsibility of both host and parent authorities.

For supervision of subsidiaries of foreign banks which have branches in India as also for subsidiaries of Indian banks abroad, RBI would need to develop a more focussed policy. At present, the supervision of the subsidiary does not seem to attract enough attention of the regulator.

For joint ventures, the supervision should normally, for practical reasons, be primarily the responsibility of the authorities in the country of incorporation.

This is our position as well.

2. Liquidity

Allocation of responsibilities for the supervision of the liquidity of banks' foreign establishments will depend upon the type of establishment concerned.

Liquidity of branches of banks incorporated abroad and functioning in the country as well as those of Indian bank branches abroad are monitored.

For branches, host authorities will often be best equipped to supervise liquidity as it relates to local practices and regulations and the functioning of their domestic money markets. At the same time, the liquidity of all foreign branches will always be a matter of concern to the parent authorities, since a branch's liquidity is frequently controlled directly by the parent bank and cannot be viewed in isolation from that of the whole bank of which it is a part. Parent authorities need to be aware of parent banks' control systems and need to take account of calls that may be made on the resources of parent banks by their foreign branches. Host and parent authorities should always consult each other if there are any doubts in particular cases about where responsibilities for supervising the liquidity of foreign branches should lie.

Foreign banks operating in the country are required to bring in capital funds and minimum CAR is also stipulated for such branches. Systems are also in place whereby RBI can take into account calls that may have to be made by them on their parent banks. This is also periodically monitored. In the case of Indian banks with branches abroad, systems are in place for monitoring liquidity by means of periodical returns.

For subsidiaries, primary responsibility for supervising liquidity should rest with the host authority.

This principle is accepted with the provision that in the case of Indian subsidiaries of foreign banks engaged in activities not coming within the regulatory purview of Reserve Bank of India, the liquidity position of such subsidiaries is not monitored by RBI.

For joint ventures, primary responsibility for supervising liquidity should rest with the authorities in the country of incorporation.

Within the framework of consolidated supervision, parent authorities have a general responsibility for overseeing the liquidity systems employed by the banking groups they supervise and for ensuring that these systems and the overall liquidity position of such groups are adequate.

RBI is, at present, a little away from the stage of consolidated supervision. It needs to move in that direction gradually.

The first step in this direction would be to pay more attention to the operation of subsidiaries even if their accounts are not consolidated with that of the present entity, which is the subject of RBI's regulation.

3. Foreign exchange operations and positions

As regards the supervision of banks' foreign exchange operations and positions, there should be a joint responsibility of parent and host authorities.

Internal control guidelines as well as proper reporting systems for foreign exchange operations are in place for both foreign branches of Indian banks and Indian branches of foreign banks.

In so far as supervision of foreign banks' own exchange operations, as separate from their Indian branches' foreign exchange operations, is concerned, RBI does not take any supervisory stance. It is considered that it is neither feasible nor necessary to cover the overall angle at this stage. The joint responsibility mentioned in the concordat is taken to mean responsibility in respect of the foreign exchange operations of the branches of foreign banks operating in India.

Minimum standards

Indian position

Remarks

I. Authorisation

1.

Host authorities should as a matter of routine check that the parent authority has no objection before granting a banking licence.

Before granting permission to a foreign bank for opening a branch in India, prior consent of the parent authority is ensured.

2.

Where a host authority is unable to obtain a positive response from the parent authority, it should consider either refusing the application, increasing the intensity of supervision or imposing conditions on the grant of authorisation. In the latter case, it is recommended that the conditions (and any subsequent changes in the conditions) should be communicated to the parent authority.

RBI considers it essential to obtain the parent authorities' consent before allowing any foreign bank to open a branch in India.

3.

Host authorities should exercise particular caution in approving applications for banking licenses from foreign entities which are not subject to prudential supervision in the parent country of joint ventures for which there is no clear parental responsibility. In such circumstances, any authorisation should be contingent on the host authority's capacity to exercise a parental role.

The principle is accepted. However, as yet there has been no occasion for RBI to permit opening of a bank in India where due to its joint venture character there is lack of clarity about the parent authority and its supervision over its foreign branches.

4.

If the host authority follows the procedure outlined in sub-section (i), a parent authority which disapproves of its bank's plans to establish abroad can recommend the host authority to refuse a licence. Parent authorities nonetheless should ensure that they have taken adequate steps to prevent their banks establishing in unsuitable locations or making inappropriate acquisitions. Where the parent supervisor imposes conditions on a foreign establishment, such conditions should be communicated to the host authority.

Indian banks are not permitted to open any branch abroad without permission of the Reserve Bank. Opening branches or making any acquisition abroad is subject to a thorough appraisal. Conditions imposed on a foreign establishment are communicated to the host authority.

II. Information needs of parent authorities

1.

Host and parent authorities should seek to satisfy themselves that banks' internal controls should include comprehensive and regular reporting between a bank's foreign establishments and its head office.

While RBI ensures that the branches of Indian banks abroad are controlled properly by banks' head offices and that suitable control mechanisms for the purpose are in place, in regard to the quality of control exercised by Head office of foreign banks, whose branches are operating in India, the position is not as unambiguous.

The information flow between the branches (of foreign banks) and the quality of internal control is taken more as a matter between the branch and its HO. The approach is that such internal control is primarily the responsibility of the head office and also on the assumption that any deficiency will be brought to its notice by the bank's head office as well as the parent supervisor. It is suggested that RBI may increase its reliance on the parent country supervisor and convey to them its expectation about being informed about the extent and quality of control maintained by the head office on its branches operating in India.

2.

If a host authority identifies, or has reason to suspect, problems of a material nature in a foreign establishment, it should take the initiative to inform the parent supervisor. The level of materiality will vary according to the nature of the problem. Parent supervisors may wish to inform host authorities as to the precise level of materiality which would trigger their concern, for the level of materiality is principally a matter for the parent authority's judgement. However, the host authority is often in the best position to detect problems and therefore should be ready to act on its own initiative.

System for informing parent supervisor in respect of problems of a material nature is in vogue. However, no specific level of materiality is prescribed or conveyed in advance to host supervisors in respect of foreign establishments of Indian banks.

RBI is not receiving from any of the parent supervisors advices about the levels of materiality which would trigger its concern.

The parent supervisor may define levels of materiality in respect of major financial parameters, the failure to meet with which or the occurrence of certain significant adverse events should be reported by the host supervisor to it.

In order to make this practice effective, we think the two supervisors will need to come to some kind of mutual agreement so that their perception about the triggers identified are common and the manners in which their respective concerns following the appearance of triggers are to be expressed do not vary too much.

3.

Parent authorities may wish to seek an independent check on data reported by an individual foreign establishment. Where inspection by parent supervisors is permitted, host authorities should welcome such inspections. Where inspection by parent supervisors is not at present possible (or where the parent authority does not use the inspection process), the parent authority can consult the host authority with a view to the host authority checking or commenting on designated features of the bank's activities, either directly or through the use of the external auditor. Whichever method is chosen, it is important that the results obtained should be available to both host and parent supervisor.

While Indian laws do not prohibit inspection of foreign bank branches by the respective parent supervisor, this is not reciprocated by all countries. The importance of both parent and host supervisor remaining fully informed and exchanging information about the condition of a branch operating abroad is well appreciated.

A country-by-country review would need to be made and appropriate action taken to enter into suitable arrangements with the host country regulation. This should receive urgent attention in relation to those countries which do not permit inspection by the parent country supervisor.

4.

If serious problems arise in a foreign establishment, the host authority should consult with the head office or parent bank and also with the parent authority in order to seek possible remedies. If the host authority decides to withdraw banking authorisation from a foreign establishment or take similar action, the parent authority should, where possible, be given prior warning.

Systems are in place for consulting with head office / parent bank and also with the parent authority whenever serious problems arise in a foreign bank branch operating in the country.

III. Information needs of host authorities

1.

Parent authorities should inform host authorities of changes in supervisory measures which have a significant bearing on the operations of their banks' foreign establishments. Parent authorities should respond positively to approaches from host authorities for factual information covering, for example, the scope of the activities of a local establishment, its role within the banking group and the application of internal controls and information relevant for effective supervision by host authorities.

Exchanges of such information between parent and host supervisors suo moto is not quite common. Reserve Bank has, however, been providing the host authorities with all such information that they have sought.

In its own turn, RBI has so far not been seeking much information from the parent authorities of banks operating in India. In certain areas of their operations, particularly about the internal about the internal controls exercised by the concerned head offices of banks, more information is desirable. RBI may consider taking steps in that direction.

2

Where a parent authority has doubts about the standard of host supervision in a particular country and, as a consequence, is envisaging action which will affect foreign establishments in the territory concerned, advance consultation is recommended so that the host authority may have an opportunity to correct any inadequacies.

The quality of host supervision differs from country to country.

System of advance consultation with the host/parent supervisors is in vogue.

A periodic review would need to be made of the supervisory systems and standards of host supervision where Indian banks have a presence.

3.

In the case of particular banks, parent authorities should be ready to take host authorities into their confidence. Even in sensitive cases such as impending changes of ownership or when a bank faces problems, liaison between parent and host authorities may be mutually advantageous.

Parent authorities do not always take the host supervisors into confidence when there are significant events relating to some specific bank, such as impending change in ownership or merger, likely to take place. In the Indian context, this is probably due to the small contribution of Indian operations to the global business of these banks, with the exception of a few.

Greater mutual understanding on the issue would need to be developed amongst the supervisors.

4.

If a parent authority is intending to take action to protect the interests of depositors, such action should be coordinated to the extent possible with the host supervisors of the bank's foreign establishments.

Recent developments, particularly those in the South East Asian countries where large scale bank restructuring took place and is still taking place, show that parent authorities are not always following this as a norm.

RBI should insist on such information sharing as one of the terms on which it permits a foreign bank to open its branch in India.

IV. Removal of secrecy constraints

1

Information received should only be used for purposes related to the prudential supervision of financial institutions. It should not be released to other officials in the recipient's country not involved in prudential supervision.

Secrecy of supervisory information is ensured.

2.

The arrangements for transmitting information should be reciprocal in the sense that a two-way flow should be possible, but strict reciprocity in respect of the detailed characteristics of the information should not be demanded.

Sharing of information is reciprocal and need based.

3.

The confidentiality of information transmitted should be legally protected, except in the event of criminal prosecution. All banking supervisors should, of course, be subject to professional secrecy constraints in respect of information obtained in the course of their activities.

Confidentiality of supervisory information is ensured.

There is perhaps a case for incorporating strict legal provisions in this regard so that supervisory information should not be shared with any agency, including central or state level vigilance/investigative agencies, but only when specifically called for by a court of law.

As a related BIS document states, it needs to emphasised, even in the event of a court demanding supervisory information, that making such information public may result in the drying up of such information and thus adversely affect the quality of supervision in the long run.

The recipient should undertake, where possible, to consult with the supervisor providing the information if he proposes to take action on the evidence of the information received.

The actual position may vary from case to case. Usually, such consultation with supervisor, after the information has been parted with, does not take place.

Consultation with the supervisor providing the information should be stipulated by law in order to safeguard the integrity and credibility of supervisory system and has relationship of trust between parent and host supervisors.

V. External audit

1.

The existence of adequate provision for external audit should be a normal condition of authorisation for new establishments. It would be advantageous for the audit firm to be one that audits the parent bank, provided the firm in question has the appropriate capacity and experience in the local centre. Where a foreign affiliate is audited by a different firm, the external auditor of the parent bank should normally have access to the audit papers of the affiliate.

Foreign establishments of Indian banks are usually submitted to an external audit in the host country. Similarly, foreign bank branches in India are submitted to external audit.

Audit reports of Indian bank branches are available to the auditors of the parent bank.

2.

Supervisors have an interest in the quality and thoroughness of audit. In the case of audits that are inadequately conducted, supervisors should address criticism to the local representative body of auditors and should be empowered, where necessary, to have the auditor replaced. As a means of raising auditing standards for international banks, internationally qualified auditors with experience of banking audit in the country concerned should be appointed. Where any doubt arises, host and parent authorities should consult.

In case of problems with quality and thoroughness of audit, RBI takes up with representative body of auditors. Systems are also in place for changing auditors and 'resting' them for a period in cases of noticeable deficiencies. The present arrangement in this regard is considered adequate.

3.

External auditors may also be asked to verify the accuracy of reporting returns or compliance with any special conditions. It is recommended that all supervisory authorities should have the ability to communicate with banks' external auditors and vice versa. Any emphasis on the role of external auditors should, however, in no way be such as to as downgrade the need for sound internal controls, including provision for effective internal audit.

RBI at present is not normally following the practice of asking external auditors to verify the accuracy of reporting returns or compliance with any special conditions.

RBI could supplement its own supervisory mechanism by making it a regular practice of using external auditors to look specially in certain selected areas and report to it independently.

No.

Minimum standards

Indian position

Remarks

1.

In order to exercise comprehensive consolidated supervision of the global activities of their banking organisations, home supervisors must be able to make an assessment of all significant aspects of their banks' operations that bear on safety and soundness, wherever those operations are conducted and using whatever evaluative techniques are central to their supervisory process.

Reserve Bank of India's supervisory stance is aimed at exercising comprehensive and consolidated supervision of the global activities of the Indian banks. However, in this regard it faces constraints in countries where the local laws do not permit the home supervisor to conduct on-site inspection/examination of records.

There is no legal or other hindrance to parent supervisors from other countries conducting such inspections of Indian branches of banks under their supervisory jurisdiction.

A country-wise analysis will have to be made and suitable action taken to address the constraints.

2.

Home supervisors need to be able to verify that quantitative information received from banking organisations in respect of subsidiaries and branches in other jurisdictions is accurate and to reassure themselves that there are no supervisory gaps

In regard to the quantitative information received from banks in respect of their branches abroad, RBI depends upon the banks providing this information for their accuracy. Such cross checks as are there are also based on the information available from the banks themselves as RBI does not consider it necessary to collect any independent information for reassuring itself that there are no supervisory gaps. At present, the foreign operations of all Indian banks constitute a small part of their total operations, say, less than 20 per cent and therefore the current methodology is considered acceptable.

3.

While recognising that there are legitimate reasons for protecting customer privacy, the working group believes that secrecy laws should not impede the ability of supervisors to ensure safety and soundness in the international banking system

We are in agreement with the view. Where safety and soundness in the international banking system is likely to come in question, customer privacy should have to lose priority.

4.

If the home supervisor needs information about non-deposit operations, host supervisors are encouraged to assist in providing the requisite information to home supervisors if this is not provided through other supervisory means. The working group believes it is essential that national legislation that in any way obstructs the passage of non-deposit supervisory information be amended.

We are in agreement with the view. In India there is no legislation at present obstructing passage of non-deposit supervisory information either to the parent office or to the home supervisor of the branches of foreign banks.

5.

Where the liabilities side of the balance sheet is concerned, home supervisors do not routinely need to know the identity of individual depositors. However, in certain well-defined circumstances, home supervisors would need access to individual depositors' names and to deposit account information.

We are in agreement with this view subject to a prior mutual agreement as regards what are "well-defined circumstances" in which the home supervisor would need access to individual depositor names and account information. Customer privacy cannot be easily and routinely compromised as it can have serious implication on the banking system. For this arrangement to work it will have to be the basis of mutuality between home and host supervisors and all supervisors would need to agree to it.

6.

It should not normally be necessary for the home supervisor to know the identity of investors for whom a bank in a host country is managing investments at the customer's risk. However, in certain exceptional circumstances, home supervisors would need access to individual investors' names and to investment account information subject to the safeguards in paragraph 10.

Our views on the issue are the same as in the case of item (v).

7.

The working group recommends that host supervisors whose legislation does not allow a home supervisor to have access to depositor information use their best endeavours to have their legislation reviewed and if necessary amended to provide for a mechanism whereby in exceptional cases a home supervisor, with the consent of the host supervisor, will gain access to depositor information subject to the same conditions as outlined in (viii) below.

No such restrictions exist in the country.

Laws in India at present do not debar the sharing of depositor information by a branch of foreign bank with its parent office or the home supervisor.

8.

In order to provide legitimate protection for bank customers, it is important that the information obtained by home supervisors especially that relating to depositors' or investors' names, is subject to strict confidentiality. The working group recommends that those host jurisdictions whose legislation allows foreign supervisors to have access to banks' depositor or investor information should subject such access (at the host country's discretion) to the following conditions

• the purpose for which the information is sought should be specific and supervisory in nature;

• information received should be restricted solely to officials engaged in prudential supervision and not be passed to third parties without the host supervisor's prior consent;

• there is assurance that all possible steps will be taken to preserve the confidentiality of information received by a home supervisor in the absence of the explicit consent of the customer;

We are in agreement.

RBI is at present not specifying such conditions. It may consider stipulating these conditions whenever foreign supervisors are to be given access to bank's depositor or investor information.

• there should be a two-way flow of information between the host and home supervisors, though perfect reciprocity should not be demanded.

We do not see any reason why perfect reciprocity should not be demanded. In fact, it is felt that without an understanding of perfect reciprocity it would be difficult to put such an arrangement in place.

• Before taking consequential action, those receiving information will undertake to consult with those supplying it.

Such consequential action shall only be supervisory and prudential.

9.

If a host supervisor has good cause to doubt a home supervisor's ability to limit the use of information obtained in confidence solely for supervisory purposes, the host would retain the right not to provide such information.

It is not quite clear how this provision can coexist with the provision suggested earlier that secrecy laws should not impede the ability of the supervisors to ensure safety and soundness in the international banking system. (Item (iii) above).

Also, without objective reciprocity on the issue of sharing information between supervisors, information flow may become very uneven making cross-border supervision difficult.

10.

Subject to appropriate protection for the identity of customers, home supervisors should be able at their discretion, and following consultation with the host supervisor, to carry out on-site inspections in other jurisdictions for the purposes of carrying out effective comprehensive consolidated supervision. This ability should include, with the consent of the host supervisor and within the laws of the host country, the right to look at individual depositors' names and relevant deposit account information if the home supervisor suspects serious crime as defined in section (d). If a host supervisor has reason to believe that the visit is for non-supervisory purposes, it should have the right to prevent the visit taking place or to terminate the inspection.

We are in agreement with this view.

11.

It would avoid potential misunderstandings if a standard routine were laid down for conducting cross-border inspections along the lines recommended.

Standard routine is not implemented as of now. Nor is it demanded of parent supervisors inspecting branches in India. A standard routine for conducting cross-border inspection as proposed would be difficult.

12.

In those countries where laws do not allow for on-site inspections use their best endeavours to have their legislation amended. In the meantime, host supervisors should, within the limits of their laws, be willing to co-operate with any home supervisor that wishes to make an inspection. The working group believes that the host supervisor should have the option to accompany the home supervisor throughout the inspection.

We agree. Inspections by the home supervisors are not impeded in any way in India.

13.

It is important that the confidentiality of information obtained during the course of an inspection be maintained. Home supervisors should use their best endeavours to have their legislation modified if it does not offer sufficient protection that information obtained for the purposes of effective consolidated supervision is limited to that use.

We agree. However, the present legal provisions in India in respect of confidentiality of information available with the home supervisor (RBI) do not seem to be providing sufficient protection of information. More clearly defined laws would be needed for this purpose.

14.

In the event that a home supervisor, during an on-site inspection in a host country detects a serious criminal violation of home country law, the home supervisor may be under a strict legal obligation to pass the information immediately to the appropriate law enforcement authorities in its home country. In these circumstances, the home supervisor should inform the host supervisor of the action he intends to take.

We agree.

15.

In order to carry out effective comprehensive consolidated supervision, home supervisors also need information on certain qualitative aspects of the business undertaken in other jurisdictions by branches and subsidiaries of banking organisations for which they are the home supervisor. All members of the working group agree that it is essential for effective consolidated supervision that there are no impediments to the passing of such qualitative information to the home supervisor.

There is no restriction in India for passing on such information to other country supervisors regarding the branches of banks under their jurisdiction.

A country-wise analysis will have to be made to ensure reciprocity in this arrangement.

16.

In the case of information which is specific to the local entity, an early sharing of information may be important in enabling a potential problem to be resolved before it becomes serious. The home supervisor should therefore consult the host supervisor in such cases and the latter should report back on its findings. In particular, it is essential that the home supervisor inform the host supervisor immediately if the former has reason to suspect the integrity of the local operation, the quality of its management or the quality of internal controls being exercised by the parent bank.

We are in agreement with this view. This arrangement is likely to improve supervisory efficiency.

17.

A home supervisor should have on its regular mailing list for relevant material all foreign supervisors which act as hosts to its banks.

This may not be necessary as it could lead to much flow of sparingly needed information between the supervisors. Any information, wherever required is likely to be available on demand or already made public by the concerned supervisor, e.g., on their web sites.

18.

While the working group agrees that home supervisors should endeavour to keep host supervisors apprised of material adverse changes in the global condition of banking groups, the Group recognises that this typically be a highly sensitive issue and that decisions on information-sharing necessarily will have to be made on a case-by-case basis.

There cannot be a settled principle on this since it has to be decided on a case-by-case basis.

19.

The working group has formulated a set of principles of effective consolidated supervision which could be used by host supervisors as a checklist to assist in determining whether a home supervisor is meeting the Minimum Standards.

The checklist provided by the working group can act as a good tool for assessing the capabilities of any supervisor to exercise consolidated supervision. However, any assessment of this nature can become arbitrary and lead to considerable difference of opinion between the host and home supervisors. Unless, therefore, there is a general consensus amongst all supervisors on the scope and methodologies of exercising consolidated supervision and until there is an agreement between most supervisors on its acceptance as the common mode of supervision, this approach if insisted upon could become counterproductive.

The principle of consolidated supervision is unexceptionable. Reserve Bank needs to move in that direction. The accounting standards as well as the regulatory provisions need to be reviewed from this angle. A major obstacle in this regard which is faced by us is multiplicity of regulators on mutually exclusive basis. A suitable mechanism to co-ordinate their approaches shall have to be found.

20.

Regional group procedures might be used to support the implementation of the Minimum Standards, as the Offshore Group is now doing.

Our views are as expressed in regard to item xix.

21.

The working group recommends that other regional groups consider the possibility of using a checklist similar to the one used by Offshore Group as a means of establishing which of their members might be certified as meeting certain general criteria.

Our views are as expressed in regard to item xix.

22.

The Basle Committee encourages its member countries to assist the Offshore Group or another regional group in the fact-finding verification process, but any decision-making regarding membership of a regional group should be left to the group alone. The Committee has asked its Secretariat to maintain a list of competent persons (for example, retired supervisors) who are available to undertake exercises of this nature.

No comments.

23.

The supervisor that licenses a so-called shell branch has responsibility for ensuring that there is effective supervision of that shell branch. No banking operation should be permitted without a licence, and no shell office should be licensed without ascertaining that it will be subject to effective supervision. In the event that any host supervisor receives an application to license a new shell branch that will be managed in another jurisdiction, that supervisor should take steps to notify both the home supervisor and the appropriate host supervisor in the other jurisdiction in order to establish that there will be appropriate supervision of the branch before approving the application.

RBI's position on these issues is the same as stated in the BIS document. It does not permit any banking operations without a licence. It also does not allow opening of any kind of branch of an Indian bank, unless it is satisfied that the branch will be subject to effective supervision.

24.

Home supervisors should not authorise their banks to establish or acquire offices in any host jurisdiction without satisfying themselves in advance that such offices will be subject to appropriate supervision.

This is being ensured while granting permission for opening of branches abroad.

25.

Where the home authority wishes to inspect on-site, they should be permitted to examine the books of the shell branch wherever they are kept. The working group believes that in no case should access to these books be protected by secrecy requirements in the country that licenses the shell branch.

We are agreeable to this suggestion.

26.

The working group recommends that home or host supervisors be vigilant to ensure that parallel-owned banks (where a bank in one jurisdiction has the same ownership as a bank in another jurisdiction, where one is not a subsidiary of the other) become subject to consolidated supervision, if necessary by enforcing a change in group structure as indicated by the Minimum Standards.

We are in agreement with this suggestion.

27.

Any home supervisor that licenses a banking entity has a responsibility to monitor its operations on a world-wide basis.

This is being ensured.

28.

No entity should be allowed to use the word "bank" in its name if it is not conducting banking activities and being supervised as a bank.

This is provided for in law.

29.

The working group believes the Basle Committee should advise all host countries to be extremely cautious about approving the establishment of cross-border operations by banks incorporated in under-regulated financial centres, and even more cautious about accepting other financial institutions conducting banking activities from those centres.

RBI's approach on these issues is in line with the thinking of the working group.

1. Board of directors and senior management are ultimately responsible for the performance of the bank. Supervisors typically check that a bank is being properly governed and bring to management's attention any problem that they detect through their supervisory efforts.

The Reserve Bank of India as supervisor checks the governance practices at banks and brings to the management's attention the problems identified by them.

Because of R.B.I./Government ownership of the banks (in the public sector), there is some overlap in the role of the R.B.I. as owner/owner's representative and as the regulator/supervisor. This overlap needs to be corrected so that R.B.I. can perform its regulatory/supervisory role without any hindrance.

2. Attentive to any warning signs of deterioration in the management of the bank's activities.

The Reserve Bank of India as supervisor, through on and off site supervision mechanisms, is attentive to warning signs of deterioration in management of a bank's activities.

Government ownership of banks, however, stands in the way of any serious and urgent corrective action on the part of R.B.I. as regulator. Laws of the land and the implied delay in the judicial system have also come in the way even where corrective action like removal of the incompetent management is contemplated.

3. Issue guidance to banks on sound corporate governance and pro-active practices.

The Reserve Bank of India as supervisor pro-actively and timely issues guidance to banks on sound corporate governance practices.

4. Sound corporate governance considers interest of all stakeholders, including depositors, whose interests the supervisors should protect.

The basic spirit of banking supervision in India is to ensure that banks follow principles of sound banking and that the interests of all stakeholders, including depositors, are protected.

5. Should expect banks to implement organisational structure to ensure checks and balances.

The Reserve Bank of India as supervisor ensures that banks have organisational structure to ensure proper checks and balances.

6. Emphasise accountability and transparency.

The Reserve Bank of India as supervisor emphasises accountability and transparency in banks.

The standards of transparency would need to be raised. A fair beginning has been made in this regard but the approach of the banks and the applicable accounting standards will have to be changed for achieving greater transparency in banking operations and accounting.

The stress on accountability largely ends up with efforts to fix accountability for loans/advances that go bad. Accountability for non-performance, at any level including that of the Board of Directors is nearly absent. This issue needs urgent attention.

7. Determine that board and senior management have in place processes that ensure they are fulfilling all of their duties and responsibilities.

Either on their own or under the guidance of Reserve Bank of India as supervisor, most banks have put in place processes designed to monitor performance and fulfillment of duties and responsibilities at different levels.

The Boards of banks, however, do not seem to subject themselves to any measure of accountability or performance either set by them voluntarily or made applicable to them externally. This leaves them as largely without any accountability either to the institution itself or to the supervisor. The situation calls for correction.

BIS Principle

Position of banks in India

Remarks

1. Internal Rating approach should normally take into account the following :

1. Borrowers probability of default (PD),i.e. the probability that the borrower may not be able to fully/ partially meet his commitment towards principal and interest;
2. The facility's loss given default (LGD), i.e., the percentage of exposure that is lost when the default occurs;
3. The level of exposure at the time of default (EAD);
4. The credit's expected loss (EL), which is the function of these variables. EL equals default probability times the loss given default. This is the loss that is expected to devolve on the bank in respect of an asset, on the basis of historical data;
5. The unexpected loss (UL) associated with these and possibly due to other characteristics of the borrowers and exposures. Unexpected loss represents the volatility in the rate of recovery and deviations from the estimated probability of default at certain confidence levels. While reserves and provisions are expected to care of the expected loss component, the unexpected loss is to be covered by Economic Capital.

1. The Internal Rating approach, as practiced by most of the banks in India, measures the risk by quantitative mode.
2. Such a system presently takes into account only the probability of default.
3. A system for measuring expected and unexpected losses is yet to be put in place in most banks.
4. The important inputs in risk rating systems of banks in India are financial analysis, projections and sensitivity and incidence of industrial and management risks.
5. RBI guidelines on risk management systems in Banks state that risk management process should encompass quantifying the risk through estimating expected loan losses i.e. the amount of loan losses that bank would experience over a chosen time horizon and unexpected loan losses.

The objective of risk quantification systems like credit ratings should be to establish a scientific basis to assess and price credit risk taking into account the "expected loss" and to critically estimate the requirements of Economic Capital (Risk Capital) based on estimations of "unexpected loss".

Banks in India need to adopt at an early date systems of internal rating requiring measurement of PD, LGD, EAD. The present MIS of banks will therefore have to be suitably redesigned and their systems enabled to capture the required data in convenient and reliable manner.

2. Banks have different approaches to rating system because of factors such as

1. Differing emphasis on quantitative and qualitative risk factors;
2. Importance of each institution's credit culture and historical experience;
3. Differing judgements regarding complexity and opaqueness of risks associated with each transaction;
4. Differing responses to inherent difficulties in quantifying loss characteristics;
5. Different risks management and other uses to which rating information and risk measures are put.

1. Banks in India normally follow internal rating systems in which both qualitative and quantitative risks factors are measured and taken into account. These systems are, however, simple and not in a position to assess more opaque risks attached with complex transactions.
2. Risk measurement techniques are yet to be used for quantifying loss characteristics as such.

With growing size and complexity of operations and increasing orientation of banks towards management of risks, there is a need for the banks in India to restructure their rating systems enabling these to capture market dynamics.

1. Banks may rely on unidimensional rating system or a multidimensional system taking other factors into consideration. For example in a two dimensional rating the borrower will have an overall credit rating with separate rating for each facility.
2. Internal process by which an assigned rating could be oriented largely to broad and subjective criteria as judged by experienced credit staff;
3. Even when specific and objective criteria are applied, these criteria may be implemented through traditional financial analysis or instead through some degree of reliance on formal statistical models.

1. Banks in India normally use a unidimensional credit rating, i.e. there is an overall grade for the borrower and same grade is applicable for all facilities.
2. The credit rating system, as developed by banks in India is largely based on their experience and broadly take into account Financial factors, factors which are industry specific and management factors.
3. Above factors are generally rated separately and due weights are assigned (which is again based on the experience of respective banks)
4. To arrive at overall risk rating, the factors mentioned above are aggregated (after adjusting for their weights in the scale) and calibrated to arrive at single point indicator of risk associated with credit decision

1. Banks in India have to move towards multidimensional rating systems as there is no other reliable method of assessing risks where the activities of the clients themselves and the facilities enjoyed by them are multidimensional.
2. It is desirable that the chosen model provides for rating of multidivisional companies and greenfield projects.

B. Basic architecture of Internal Rating Based approach to capital :

Internal Rating Based approach to regulatory capital should have three basic elements :

1. To become eligible for IRB approach, a bank has to demonstrate that its Internal Rating system and processes are in accordance with minimum standards and sound practice guidelines which will be set up by Basel Committee. These guidelines would ensure the quality, usefulness and integrity of the key statistics that would form the basis of the bank's capital requirements.
2. If the bank's internal system/ procedures meet these requirements, bank need to provide to supervisors exposure amounts and estimates of key loss statistics association with these exposures (such as PD) by internal rating grade. These exposures would include both outstanding balances as well as some percentage of committed but undrawn amounts. Banks would provide information based on their own rating systems, in accordance with minimum standards and sound practice guidelines that would be set forward by the Basel Committee.
3. Based on the banks estimate of Probability of Default (PD) and estimates of Loss Given Default (LGD) and other potential asset characteristics, bank's exposure would be assigned to capital "buckets". Each bucket would have a risk weight that incorporates unexpected loss associated with estimates of PD, LGD and other losses. These risk weights would be developed by bank supervisors taking into account intrinsic risk of the asset and minimising incentives for banks to bias the assignment of Internal Rating, or to engage in capital arbitrage.

1. RBI, in their guidelines for Risk Management Systems in Banks, have stipulated that credit risk management process should be articulated in bank's loan policy, duly approved by the Board.
2. This process for Banks in India can start only after Basel Committee sets forward the minimum standards and sound practice guidelines for Internal Rating approach.

1. Any successful approach in this context would require familiarity of the functionaries with the rating process.
2. A comprehensive risk rating system should serve as a single joint indicator of diverse risk factors.
3. In the Indian context it would be necessary to strengthen the MIS and data collection machinery in the banks to ensure integrity and reliability of the data is beyond doubt.
4. The ratings should facilitate the functionaries by informing them of the quality of loan at any moment of time.

C. Range of Practice in the Rating System Structure

1. Range in Rating Systems

1. Banks in India have normally between 6-8 rating grades for non-impaired corporate loans.
2. Banks in India have normally 3 rating grades for problem loans.
3. This could be the position for banks in India also. However we need to get more data on this aspect of the present rating system of the banks in India.

D. A key element of rating system structure is the focus on characteristic of the
borrower (obligor) as opposed to specific details of transaction/ facility

1. Majority of banks have adopted a explicit obligor dimension, that is, they assign a rating which reflect the risk that borrower will default on any of its obligations.
2. One third of the banks utilise a two dimensional rating i.e. the ratings system includes both an obligor grade and a facility grade. Facility grades for different loans could differ based on collateral taken, seniority or other structural attributes of the loan.
3. Among those banks with two- dimensional rating systems, a small number appears to assign an obligor rating and as second "LGD" rating that explicitly evaluates likely recovery rates for each transaction in the event that a default were to occur.
4. In practice even banks which have only an obligor rating system in place, may implicitly take into consideration the riskiness of facilities for pricing, profitability analysis and in allocation of economic capital; in such cases, facility type LGD is mechanically derived based on the type of loan, the presence and type of collateral, and possibly other factors, in effect, outside of the rating system.

Internal Rating Systems in the Indian banking system is mostly with obligor dimension. This rating reflects the risk that the borrower will default in any of its obligations. Rating of individual facilities is yet uncommon although some banks, in recent years, have introduced differential pricing for term loans through an unique benchmark rate. However, despite the prevalence of 'only obligor' rating system, most banks in India do take into consideration, through analysis of quantitative and qualitative data, the riskiness of different facilities, profitability analysis of the various lines of business of the obligor, quality of the management, developments at the industry/business levels, etc. in arriving at the rating.

E. Categories of Rating Process :

Banks in India use a combination of both statistical based processes and constraint expert judgement processes. The expert judgement process is not in vogue especially for large corporates.

F. Risk factors considered in assigning grades

1. Financial statements such as Balances sheets, Income statements, cash flow statements etc. Those banks relying heavily on the statistical default models use specific type of financial data (e.g., specific ratios that described leverage, debt service coverage, and the like), while those banks relying on more judgmental analysis may allow discretion to the rater on analysis of these data.
2. Historical and trend data of the above financial statements. Some banks use three or more years of data.
3. Industry and peer group analysis. In this case supporting industry analysis is provided by internal economic analysis units or outside vendors, so that the different raters within the same institution would tend to incorporate a common view of the industry's outlook across all borrowers.
4. Management experience and competence (especially in areas where constrained expert judgement is used)
5. Ownership structure, reputation, quality of financial information provided, the purpose for which the loan is provided, environmental liabilities etc.
6. Country risk in case of cross border lending. Country risk is universally considered using a "sovereign ceiling" rule ( the rating of the counterparty cannot exceed the rating of the sovereign in which it is incorporated or has its principle place of business.

2. Main considerations in assessing facilities :

i. Facility characteristics such as third party guarantee, collateral and seniority / subordination of the obligations are taken into account taken into account while assigning a grade to an exposure and/or analysing internal profitability or capital allocations.

ii. Most banks allow bank guarantees to affect the rating by effectively transferring the risk to the guarantor, or, alternatively, using the more favourable of the borrower or guarantor rating.

iii. Banks providing facility grades generally did not consider the liquidity of the instrument being rated in assigning that grade.

iv. The decision to take a provision for loan losses is also considered explicitly as a factor in assigning facility ratings.

v. Maturity of the facility is considered in allocating economic capital for credit risk.

3. Use of statistical default models :

Normally internally developed models are used. These models also appear to rely on similar inputs such as balance sheet ratios, trend analysis etc. In some banks vendors provided models such as KMV's Credit Monitor are used. These are being primarily for large corporate and international borrowers.

4. Use of external rating :

Wherever available, external rating is used is assigning internal grades, mainly in cases where expert judgement based process of internal rating is used. Normally these external ratings are available only for large corporates and mainly in North America and UK.

All these factors are taken into account by banks in India while assigning grades to the borrowers in most cases.

1. These factors are taken into account by banks in India while assessing facilities for the borrowers.
2. Some of the banks in India go by the principle that availability of collateral should not influence the risk rating as collaterals help in taking a business decision while credit rating facilitate a credit decision.

Use of default models is still not common in Indian banking.

In India, external ratings are used more in investment decisions rather than in credit rating process. In India also, the ratings are available only for big corporates.

G. Time Horizon

a) Majority of the banks described the time horizon for internal rating as one year or in many cases the maturity of transaction is question. Many banks described the horizon as ambiguous, or alternatively allow raters to determine the horizon on a case- by- case basis.

b. Banks follow "either point in time" or "through the cycle" orientation. In the former process, the rating reflects an assessment of borrower's current conditions or most likely future conditions over the chosen time horizon. The latter process requires the assessment of borrower's riskiness based on worst case scenario (i.e. its conditions under stress). In this case, a borrowers rating would tend to stay the same over the course of the credit/ business cycle.

c) Banks claiming to use to use a through- cycle- process, are likely to take into account longer term negative prospects and unlikely to rely very heavily on long term projections of improvement in borrower's ability to repay as a basis for assigning a favourable internal rating. Of course, such perspective is wholly consistent with sound credit risk management.

Indian banks normally assign an internal rating for one year after which it will be revised/ renewed.

Indian banks follow "point in time" orientation for rating process.

H. Measuring Loss Characteristics by Grade

While only a very few banks in India have developed internal rating systems, even those that have such a system are yet not attempting to estimate the loss characteristics of different grades. One big hurdle in this area has been lack of availability of reliable data which is due to manual operations. Unless the risk management systems of banks in India are raised to a sufficiently high level of detail and sophistication the objectives behind measuring loss characteristics by grade as stated here will not receive the desired focus.

The banks have just begun adopting risk management systems with any degree of sophistication. It will be some time, say another 3/5 years before the whole banking system can expect to come to the level of risk management envisaged in the note. This presupposes total computerisation and the right kind of MIS. The bigger banks must however be encouraged to expedite the process of transition from the elementary levels of risk management to levels of greater sophistication more expeditiously. In this they may not be having in-house expertise and may therefore be encouraged to obtain external assistance, e.g., from consultants, etc.

I. Methods for estimating loss characteristics

As above

J. Survey Results on Probability of Default (PD)

1. Banks in India are yet to use their internal default data to arrive at PD, though some banks are attempting this process.
2. In view of the wide network of branches and the fact that many of the branches in rural and semi-urban areas have not been computerised, many operational constraints are faced by banks in building up a reliable database.

The banks in India have yet to begin using statistical default models for calculating average PDs for each internal rating grade.

K. Survey results on Loss Given Default (LGD)

1) One third of banks apply facility-specific LGD estimates to their exposures for use in internal capital allocation and/or profitability analysis system. Among the remaining majority of banks, many indicated that they did not at present estimate LGD, possibly because they do not at present operate capital allocation or profitability analysis system that make use of LGD estimates.

2) General factors considered important for estimating LGD are as under :

i) Borrower's attributes ( such as borrower's grade, country of incorporation, size, industrial sector and other factors which may affect the unsecured value remaining in the defaulted borrower, whether it continues to operate after default or is in liquidation)

ii) Facility characteristics(including the existence of credit mitigation techniques such as seniority of the structure, realisable value of the collateral taken, and the value of any other forms of credit risk mitigation such as the third party guarantee)

iii) Bank specific characteristics( such as the internal policy towards recovery), and

iv) Exogenous factors (such as the economic cycle)

3) With respect to secured facilities, banks use a variety of techniques and data sources to arrive at estimates of the value of both financial and physical forms of collateral. Some banks distinguish between "normal" and "forced sale" valuations. Some banks also request, based on the terms of the contract, additional collateral and /or other risk mitigants to maintain the expected recovery ratio.

4) As regards data used for measuring LGD, nearly all banks rely on data from their own historical records.

5) Like in the case of quantifying PDs, those banks seeking to quantify LGD also retain different definitions of what constitutes "default" as well as "loss", and relied on different assumptions about direct and indirect costs, and the time taken to ultimate workout.

N.B.: Models Task Force found survey responses insufficient to glean a consensus on a common framework or "right" LGD estimate for loans of various types. Hence it has urged banks to collect data on LGD as part of an overall approach to assessing and measuring more systematically the amount of credit risks to which they are exposed.

Banks in India are yet to go in for LGD estimates though some banks are making efforts in this direction.

It is desirable that banks build historical data base on the portfolio quantity and provisioning/ charge off to equip themselves to price the risk.

L. Survey Results on Exposure at Default (EAD)

a. It would appear that those banks that typically estimate EAD for facilities with uncertain drawdown ,such as a standby line of commitment were those banks that were using some form of capital allocation model. In these cases, EAD is equated to the sum of (1) balances actually drawn and (2) committed but undrawn exposures multiplied by a factor of "x". Key variables having a bearing on the EAD estimate included current outstandings, committed funds, facility structure, and borrower ratings. In the calculation of conversion factor few banks made distinctions in terms of maturity.

b. To an even greater degree than with LGD, banks rely heavily on internal data and studies based on their own historical experience while estimating EAD values. The banks that estimate a facility's EAD for use in capital allocation and profitability systems do so based only loosely on historical or statistical analysis, and incorporate substantial elements of business judgement and conservatism into these figures.

Banks in India are yet to go for estimation of EAD, though some banks are attempting on these lines.

M. Applications of Rating systems.

3. Decisions on reserve levels: One third of the banks relate the level of reserves to the rating classes. Remaining banks also implicitly consider the rating information when determining reserves.

4. Economic capital allocation: About half the banks surveyed use rating information for attributing economic capital to product or business lines.

5. Compensation for relationship managers: One third of the banks base compensation for relationship managers on ratings. A number of banks which calculate risk adjusted return on economic capital on rating information also noted that they base incentive-based compensation on this measure.

6) Setting of credit limits: More than half the banks indicated that limits are set based on rating categories. A few banks explicitly noted that loan approval authority is tied to rating categories.

1. The rating system is being put to similar use by some banks in India also.

 

 

2. Internal rating grades are used for pricing by some banks.

 

3. In the Indian system, reserves are created/provisions made on the rating of individual accounts and not in aggregate for a whole grade. Even though a uniform reserve is created for all standard assets, this reserve is the same across different grades as longs the relative advances are standard, i.e., performing.
4. This is being attempted here
5. Neither the compensation package nor performance accountability is in any manner related to the rating categories.
6. Internal rating grades are not being used for this purpose. The exposure limits to borrowers and sanctioning powers are mostly independent of the rating category in which a particular loan proposal may be falling.

The banks which are not following this practice as of now may be advised by RBI to do so.

N. Oversight and Control of Internal Rating System :

1)Though primary responsibility for initially proposing rating for borrowers varied widely, ratings for large corporates must be approved by credit staff, although the rating may be initially proposed by relationship managers.

2) Most of the banks indicated that credit culture was very important in ensuring accuracy and consistency of rating assignments.

3) All the credit decisions are documented adequately.

4)There was little information provided on loan review units, although some banks indicated that loan review staff reviewed loans on a sampling basis, usually, from riskier loans or in growing areas of lending concentration.

5) All banks conduct a formal review of each risk rating atleast once a year. The frequency of review depends on the riskiness of the loan and collateral.

1. Some banks follow this practice here as well whereby rating is initially recommended by the relationship manager and reviewed by the credit department.
2. Strong credit culture is in place in many of the banks in India.
3. All credit decisions are documented adequately.
4. Many banks in India conduct credit audits of large loans within three to six months of sanction and disbursal.
5. All banks conduct formal renewal of risk rating once a year. Periodical reviews are done on risky exposures.
6. Periodical review of ratings system is also undertaken.
7. The rating systems are mostly being developed internally. Some banks use scoring models to identify riskiness of exposures.
8. This is true of India as well.
9. The rating systems are well documented and the documentation is made available to the concerned staff.
10. The rating processes are reviewed periodically but backtesting is not yet in vogue.

O. Future steps for supervisors

Systematic risk management has only recently been introduced in Indian banks. Most banks are in the process of setting up a system which is simple. Sophistication will be introduced only with passage of time as the banks increase that affinity with the existing system and have improved their MIS substantially. Most of the concepts discussed here are yet to be introduced to the banks

1. Allocation of economic capital on the basis of risk or variability of returns has gained international acceptance and supervisors are planning to evaluate the internal capital adequacy assessment of banks.
2. Banks in India would have to formulate a medium term strategy to implement Risk Aggregation and Capital Allocation mechanism.
3. RBI may consider guiding the banks to more sophisticated risk management concepts in a time bound manner. It may consider directing some more capable and better equipped banks to adopt higher practices without waiting for the whole banking system. Such banks acting as leaders could provide models for other banks to convert to.