2.59 As at end-March 2001, the gross NPAs of all private sector banks stood at Rs.6,039 crore with an increase of 26.8 per cent during the year. The private sector bank group witnessed an increase in the ratios of gross NPAs to total assets and gross NPAs to gross advances. The ratio of gross NPAs to gross advances increased to 8.5 per cent and that to total assets increased to 3.7 per cent. The ratio of net NPAs to net advances remained unchanged at 5.4 per cent as also the ratio of net NPAs to total assets (2.3 per cent).

2.60 The gross NPAs of old private banks increased by 15.9 per cent to Rs.4,420 crore as at end-March 2001 from Rs.3,815 crore as at end-March 2000, while net NPAs increased by 15.8 per cent to Rs.2,770 crore from Rs.2,393 crore during the same period. The ratio of gross NPAs to total assets remained unchanged at 5.2 per cent for old private sector banks as also the ratio of net NPAs to total assets at 3.3 per cent. The ratio of gross NPAs to gross advances increased from 10.8 per cent to 11.1 per cent and that of net NPAs to net advances increased from 7.1 per cent to 7.3 per cent. Out of the 23 old private banks functioning as at end-March 2001, 16 banks had net NPAs up to 10 per cent of net advances, 4 banks had net NPAs between 10 and 20 per cent of net advances and 3 banks had net NPAs in excess of 20 per cent (Table II.17).

2.61 Gross NPAs of new private sector banks increased by 71.1 per cent to Rs.1,619 crore as at end-March 2001 from Rs.946 crore as at end-March 2000, while net NPAs increased by 45.6 per cent to Rs.929 crore from Rs. 638 crore. The ratio of gross NPAs to total assets increased from 1.6 per cent to 2.1 per cent. The ratio of gross NPAs to gross advances increased from 4.1 per cent to 5.1 per cent and the ratio of net NPAs to net advances from 2.9 per cent to 3.1 per cent. All eight new private sector banks had net NPAs within 10 per cent of net advances as at end-March 2001 (Table II.17).

2.62 The gross NPAs of foreign banks increased by 17.5 per cent to Rs.3,071 crore during 2000-01, while net NPAs declined by 6.4 per cent to Rs.800 crore. The ratios of both gross and net NPAs to total assets declined during the year under review. The ratio of gross NPAs to gross advances declined from 7.0 per cent to 6.8 per cent, and the ratio of net NPAs to net advances from 2.4 per cent to 1.9 per cent. The proportion of standard assets increased to 93.1 per cent from 93.0 per cent a year ago. Out of 42 foreign banks, 31 had net NPAs up to 10 per cent, 6 between 10 per cent and 20 per cent and 5 had net NPAs in excess of 20 per cent (Table.II 17). Bank-wise details of NPAs of foreign banks are given in Appendix Tables II.9 (E) and (F).

2.63 The incremental gross NPAs, as percentage of incremental gross advances and incremental total assets, increased for all bank groups during 2000-01, except for State Bank group. In absolute terms, the incremental gross NPAs was higher at Rs. 3,475 crore in 2000-01 as compared to Rs.1,686 crore in 1999-2000, while incremental net NPAs increased from Rs.2,053 crore in 1999-2000 to Rs.2,394 crore in 2000-01 (Table II.18). As percentage of incremental advances, the incremental gross NPA ratio of SCBs rose from 2.2 per cent in 1999-2000 to 4.2 per cent in 2000-01, with the same for PSBs increasing from 2.4 per cent to 2.8 per cent. In net terms, the incremental net NPA ratio increased from 2.7 per cent in 1999-2000 to 2.9 per cent in 2000-01 (Table II.19). As ratio to incremental assets, while the incremental gross NPA for SCBs increased from 1.1 per cent to 1.8 per cent in 2000-01; over the same period, the incremental net NPA ratio has remained unchanged at 1.3 per cent.

2.64 As at end-March 2001, 23 out of the 27 PSBs (consisting of eight banks in the State Bank group and 15 nationalised banks) had capital in excess of 10 per cent of risk-weighted assets. Among the remaining four nationalised banks, two had CRAR between 9 per cent and 10 per cent, one had CRAR between 4 per cent and 9 per cent and one had negative CRAR (Table II. 20).

2.65 Of the 23 old private banks, 16 banks had CRAR in excess of 10 per cent, four had CRAR between 9 and 10 per cent, one had CRAR between 4 and 9 per cent while two had negative CRAR. Thus, the number of old private banks having CRAR in excess of 10 per cent decreased from 18 in the previous year to 16 in 2000-01. The number of new private sector banks having CRAR in excess of 10 per cent continued to remain at seven in 2000-01 with one bank having CRAR between 9 per cent and 10 per cent. The number of foreign banks having CRAR above 10 per cent increased to 38 from 37 in the previous year (Table II.20). Bank-wise details of CRAR of individual bank groups are given in Appendix Tables II.11 (A) to (C).

2.66 The measurement of operational risk has emerged as an important aspect in the calculation of capital as per the new capital adequacy framework of the Basel Committee on Banking Supervision (BCBS). In the context of increasing globalisation, enhanced use of technology, product innovations and growing complexity in operations, the Reserve Bank agrees, as a general principle, with the Basel Committee's proposal to assign explicit capital charge for operational risk (Box II.2).

2.67 Three banks viz., Andhra Bank, Indian Overseas Bank and Vijaya Bank raised capital amounting to Rs.361.20 crore, through initial public offerings (IPO) in the market during the year 2000-01. The Ganesh Bank of Kurundwad Ltd., was granted permission to issue shares on rights basis for Rs. 0.41 crore. The Vysya Bank Ltd., was granted permission to issue preferential shares to its foreign collaborators amounting to Rs.42.49 crore.

2.68 During 2000-01, eleven public sector banks raised subordinated debt to augment their capital. These are Bank of India (Rs.200 crore), Bank of Maharashtra (Rs. 50 crore), Canara Bank (Rs. 300 crore), Central Bank of India (Rs. 250 crore), Indian Overseas Bank (Rs. 125 crore), Punjab and Sind Bank (Rs. 60 crore), Punjab National Bank (Rs. 240 crore), Union Bank of India (Rs. 100 crore), UCO Bank (Rs. 150 crore), United Bank of India (Rs. 140 crore) and Bank of Baroda (Rs. 600 crore).

2.69 During 2000-01, Andhra Bank returned Rs. 47.95 crore capital to the Government of India.

Operational risk, as defined by the Basel Committee is "the risk of direct or indirect loss resulting from inadequate or failed internal processes, people and systems or from external events". The definition excludes strategic and reputational risk, but includes legal risk. Operational risks can broadly be classified in the following categories:

Information Technology Risk – System failure, internet virus, inaccurate data, poor quality of communication, etc. Human Resources Risk – Recruitment procedures, incompetent staff, holiday policy, etc.

Loss to Assets Risk – Risk that damages assets and interrupts business. The damage could be due to fire, flood or earthquake.

Relationship Risk – Changes in regulatory requirements, claims, customer satisfaction, lawsuits, etc.

There are three approaches in the assessment of capital requirements for operational risk viz. Basic Indicator Approach, Standardised Approach and Internal Measurement Approach.

Under Basic Indicator Approach, operational risk capital is allocated using a single indicator as a proxy for an institution’s overall operational risk exposure. Gross income is proposed as the indicator, with each bank holding capital for operational risk equal to a fixed percentage, multiplied by its individual amount of gross income.

Under the Standardised Approach, bank’s activities are divided into a number of standardised business units and business lines, as given by the Bank for International Settlements (BIS). Within each business line, regulators specify a broad indicator that is intended to reflect the size or volume of a bank’s activity in the area. The indicator serves as a rough proxy for the amount of operational risk within each of these business lines. Within each business line, the required capital is calculated by multiplying an indicator, such as gross income or asset size of the business line, by a fixed percentage. The total capital charge is the simple sum of the required capital across each business line.

In the case of Internal Measurement Approach, bank’s internal loss data are used and the method to calculate the required capital is uniformly set by supervisors. Banks activities are categorised into number of business lines and a broad set of operational loss types is defined and applied across business lines. Within each business line/ loss type combination, the supervisor specifies an Exposure Indicator (EI) - a proxy for the size of a particular business line’s operational risk exposure. In addition to EI, for each business line/loss type combination, banks measure, based on their internal loss data, a parameter representing the probability of the occurrence of loss event (PE) as well as a parameter representing the loss given that event (LGE). Expected Loss (EL) is arrived at by the multiplication of EI, PE and LGE. Given the scaling factor r(i,j) (defined as the maximum amount of loss per holding period within a certain confidence interval) for each business line (i) and risk type (j) this translates the expected loss into capital charge as =Σi Σj [γ(i,j) * ΣEI (i,j) *PE (i,j) *LGE (i,j)].

Quantification of operational risk poses a major computational challenge to policy makers. Modeling operational risk in financial institutions is still in its infancy. But the process is likely to gather momentum in the future. As it stands at present, several methods have been employed including appropriate statistical distributions to estimate operational VaR. However, unlike market risk, the operational VaR is not easily obtainable. The difficulty lies in identifying the right statistical distribution that determine the severity and the frequency of a particular category of operational loss. In order to approximate the severity of operational loss, methods, like Extreme Value Theory (EVT) and Monte Carlo simulation can be fruitfully employed to calculate the operational VaR.

On the measurement of operational risk the Reserve Bank is of the view that "until a scientific method to measure the operational risk across countries is evolved, the Basel Committee should consider prescribing a lower capital charge of 15 per cent of the gross income or 10 per cent of the current capital requirement to align capital to the underlying risk profile. National supervisors may, however, be given discretion to prescribe higher capital charge towards operational risk in case of banks, which may be considered as ‘outliers’.

Basel Committee on Banking Supervision, (1998), ‘Operational Risk Management’, Bank for International Settlements, Basel, September.

Basel Committee on Banking Supervision, (1999), ‘A New Capital Adequacy Framework’, Bank for International Settlements, Basel, June.

Basel Committee on Banking Supervision, (2001), ‘Operational Risk: Consultative Document’, Bank for International Settlements, Basel, January.

Cruz M, Coleman R. & Salkin G. (1998): ‘Modeling and Measuring Operational Risk’, The Journal of Risk, Vol. 1, No. 1.

2.70 Pursuant to the guidelines issued in January 1993, the minimum capital requirement for setting up banks in the private sector was prescribed at Rs. 100 crore. Upon review of the position of the capital funds of old private sector banks in 1998-99, it was indicated that old private sector banks having networth of less than Rs. 50 crore were to attain the level of Rs. 50 crore by March 31, 2001. Accordingly, three old private sector banks having networth of less than Rs.50 crore, and 7 banks whose capital funds ranged above Rs. 50 crore but less than Rs.100 crore were advised to prepare action plans for augmenting capital funds to the level of Rs.100 crore.

2.71 The guidelines for entry of new banks in the private sector were revised in January 2001, so as to make the issue of licenses selective and restrict to the applicants who can meet the prudential requirements and provide efficient customer service. The guidelines are given in Chapter I.

2.72 Nine Indian banks (8 in public sector and one in the private sector) are operating branches abroad. During the year 2000-01 the number of Indian branches abroad stood at 94. The number of representative offices of Indian banks abroad stood at 14. The number of wholly owned subsidiaries of Indian banks abroad and joint ventures abroad stood at 15 and 5, respectively.

2.73 Foreign banks are allowed to operate in India through branches. There are 41 foreign banks from 21 countries operating in India with 194 branches as on June 30, 2001. While 5 banks have 10 or more branches, 17 are one branch banks. Twelve foreign banks have 367 ATMs located both at branches and off-sites. The branches of foreign banks are spread over 25 centres in 16 States/Union Territories. Consequent upon acquisition of the issued share capital of ANZ Grindlays Bank Ltd. from Australia and New Zealand Banking Group, Australia by Standard Chartered Bank plc, London, the name of ANZ Grindlays Bank Ltd., operating with 41 branches in India, has been changed to Standard Chartered Grindlays Bank. Further, as a result of a global merger between two Japanese banks viz., Sakura Bank and Sumitomo Bank Ltd., Indian operations of Sakura Bank have been merged with Sumitomo Bank and the latter is operating in India as a new entity viz., Sumitomo Mitsui Banking Corporation since April 2001. As on June 30, 2001, 24 banks from 12 countries had representative offices in India of which 22 were in Mumbai and one each in New Delhi and Chennai.

2.74 The outstanding deposits mobilised by Regional Rural Banks (RRBs) registered an increase of 23.2 per cent to Rs.37,027 crore in 2000-01 with demand deposits rising by 27.3 per cent. The credit extended by RRBs increased by 23.0 per cent to Rs.15,579 crore in 2000-01 and investments by 25.6 per cent to Rs.7,546 crore. The credit-deposit ratio was at 42.1 per cent in 2000-01, while investment-deposit ratio increased marginally to 20.4 per cent (Table II.21).

2.75 The loans and advances disbursed by RRBs for agriculture accounted for 47.5 per cent of total advances as on March 31, 2000. The term loans for agriculture and allied activities at Rs.3,339 crore accounted for 53.6 per cent of agricultural advances while the share of crop loans constituted 46.0 per cent. Non-agricultural advances viz., advances to rural artisans, village and cottage industries, retail trade and self-employed, etc., and others accounted for 52.5 per cent of total loans and advances as at end-March 2000 (Table II.22).

2.76 Of the 196 RRBs, the audited results for 2000-01 are available for 192 banks. The performance of RRBs during 2000-01 is indicative of an improvement in profitability. The operating profits increased by 33.2 per cent to Rs.715 crore and the net profits by 37.0 per cent to Rs.589 crore (Table II.23). The ratio of operating profits to total assets increased from 1.27 per cent to 1.47 per cent and that for net profits from 1.01 per cent to 1.21 per cent. The increase in profitability could be attributed to rise in interest income coupled with lower operating expenses.

2.77 The NPAs of RRBs declined considerably during 2000-01. The share of NPAs in total assets of RRBs declined from 23.2 per cent as at end-March 2000 to 19.2 per cent as at end-March 2001, largely due to an increase in the share of assets in standard category from 76.8 per cent in end-March 2000 to 80.8 per cent as at end-March 2001 (Table II.24).

2.78 A total sum of Rs.2,188 crore has been infused as additional capital support to 187 out of 196 RRBs through six phases of recapitalisation of the loss-making RRBs till January 2000. Out of 187 RRBs, 158 RRBs have been fully recapitalised and 29 RRBs partially. Further, while 7 RRBs are yet to be taken up for recapitalisation, 2 profit-making RRBs do not need any capital support. During the year 2000-01, recapitalisation exercise was not taken up by the Government of India and no budgetary allocation has been made for the year 2001-02.

2.79 With a view to providing an institutional mechanism for promoting rural and semi-urban savings as well as provision of credit for viable economic activities in local areas, Local Area Banks (LAB) were established in the private sector. The related guidelines were announced by the Reserve Bank in 1996. The Reserve Bank has given 'in-principle ' approval for setting up of seven LABs in the private sector. Of these, licenses were issued to five LABs, viz., (1) Coastal Local Area Bank Limited, Vijayawada in the districts of West Godavari, Krishna and Guntur in Andhra Pradesh (2) Capital Local Area Bank Limited, Phagwara in the districts of Kapurthala, Jalandhar and Hoshiarpur in Punjab, (3) Krishna Bhima Samurdhi Local Area Bank Ltd., Mehboobnagar in the districts of Raichur and Gulbarga in Karnataka and Mehboobnagar district in Andhra Pradesh, (4) Vinayak Local Area Bank Ltd., Sikar in the districts of Jhunjhunu, Sikar and Churu in Rajasthan and (5) South Gujarat Local Area Bank Ltd., Navsari in the districts of Surat, Navsari and Bharuch in Gujarat. These LABs have since commenced banking business.

2.80 Banks were given freedom to open the new branches and close unviable branches subject to the stipulations laid down by the Reserve Bank. The total number of branches of commercial banks increased to 65,800 as at end-June 2001 from 65,556 as at end-June 2000. As at end-June 2001, rural branches accounted for the highest share (49.6 per cent) of branches of commercial banks in India, followed by semi-urban branches (22.1 per cent), urban branches (15.5 per cent) and metropolitan branches (12.8 per cent) (Appendix Table II.12). State-wise and region-wise distribution of branches of commercial banks are given in Appendix Table II.13.

2.81 With progressive deregulation of interest rates, banks now have considerable flexibility to decide their deposit and lending rate structures and manage their assets and liabilities with greater efficiency. On the lending side, banks are free to prescribe their own lending rates including the Prime Lending Rate (PLR). On the deposit side, banks have been given the freedom to offer a fixed rate or a floating rate subject to the approval of their Boards.

2.82 The minimum maturity period for term deposits has been reduced to 7 days from 15 days in respect of wholesale deposits of Rs.15 lakh and above. Banks are permitted to formulate fixed deposit schemes specifically meant for senior citizens offering them higher and fixed rates of interest than normal deposits of any size. The ceiling on FCNR(B) deposits rates has been brought down to LIBOR/SWAP rates for corresponding maturity from LIBOR/ SWAP rates plus 0.50 per cent. Movement in the domestic term deposits as well as on NRE deposits, during April 2000 to October 2001 is given in Table II.25.

2.83 The concept of Tenor Linked Prime Lending Rates (TPLRs) was introduced in April 1999 to give SCBs more operational flexibility. Keeping in view the international practice and to provide further operational flexibility to commercial banks in deciding their lending rates, PLR was converted into a benchmark rate and accordingly the requirement of PLR being the floor rate for loans above Rs. 2 lakh was relaxed. Effective from April 19, 2001, commercial banks have been allowed to lend at sub-PLR rate for loans above Rs.2 lakh. Movement in the PLRs of SCBs during April 2000 to October 2001 is given in Table II.25.

2.84 Effective May 5, 2001, the rupee export credit interest rate structure was changed by prescribing ceiling rates linked to the relevant PLRs of banks. This was expected to introduce healthy competition and provide exporters a greater choice to avail of banking services in terms of interest rate, quality of service and transaction costs.

2.85 Considering the special circumstances arising out of recent global developments and consequent implications of the same for Indian trade, the Reserve Bank effected a reduction in ceiling rate on export credit by 1 percentage point across the board on September 26, 2001, which will remain valid up to March 2002 (Table II.26).

2.86 The Government of India Notification specifying insurance as a permissible form of business under Section 6(1)(0) of the Banking Regulation Act, 1949, was issued on August 3, 2000. Based on the above, detailed guidelines were issued by Reserve Bank on August 9, 2000. Since then, State Bank of India has been permitted to set up a life insurance subsidiary on risk participation basis with 74 per cent equity holding. Jammu & Kashmir Bank Ltd., and Vysya Bank Ltd., have been accorded approval to contribute 25 per cent and 49 per cent, respectively, to the equity of insurance joint ventures on risk participation basis. Punjab National Bank and Vijaya Bank were permitted to make strategic investment to the extent of 15 per cent and 8 per cent, respectively, in the life and non-life insurance joint venture and in a distribution and services company. Citibank, American Express, Standard Chartered Bank, HSBC, ABN-Amro, HDFC Bank and Deutsche Bank have been given 'in principle' approval to act as corporate agents of insurance companies for distribution of insurance products on fee basis. All these approvals have been granted subject to the banks obtaining necessary clearance from Insurance Regulatory and Development Authority (IRDA).

2.87 A clearing corporation known as Clearing Corporation of India Ltd. (CCIL) for clearing and settlement of government securities and foreign exchange transactions has been set up by SBI (chief promoter) and co-promoted by Bank of Baroda, HDFC Bank, ICICI, IDBI, and LIC in April 2001 with an authorised as well as paid-up capital of Rs.50 crore. While SBI and the co-promoters are participating to the extent of 51 per cent in the equity of the Corporation, the balance 49 per cent equity will be contributed by other banks, financial institutions, primary dealers and mutual funds. SBI has been permitted to invest 26 per cent in the equity of the Corporation amounting to Rs.13 crore whereas Bank of Baroda and HDFC Bank have been permitted to invest Rs.2.5 crore each. Permission has also been accorded to Central Bank of India to subscribe Rs.2 crore in the equity of CCIL, Rupees one crore each by Punjab National Bank and Oriental Bank of Commerce and Rs.50 lakh each by Citibank, Bank of India, Canara Bank, Corporation Bank and Union Bank of India.

2.88 The retail banking portfolio encompasses deposit and asset-linked products as well as other financial services offered to individuals for personal consumption. Retail banking is increasingly viewed by banks as an attractive market segment with opportunities for growth with profits. The products offered in the retail banking segment are housing loans, consumption loans for purchase of durables, auto loans, credit cards and educational loans. The loan values could typically range between Rs. 20 thousand and Rs.100 lakh. The loans are generally for duration of 5 to 7 years with housing loans granted for a longer duration of 15 years. Credit card is another rapidly growing sub-segment of this product group.

2.89 The growth in retail banking has been facilitated by growth in banking technology and automation of banking processes to enable extension of reach and rationalisation of costs. ATMs have emerged as an alternative banking channel which facilitate low-cost transactions vis-à-vis traditional branches. It also has the advantage of reducing the branch traffic and enables banks with small networks to offset the traditional disadvantages by increasing their reach and spread. The increased use of ATMs by foreign banks and private sector banks has helped these banks to compete with PSBs by enabling them to expand their reach and to contain costs. The use of ATM technology is quite low in the case of PSBs and the old private sector banks. Given the fact that the PSBs are in the process of rationalisation of staff strength, introduction of ATMs would help facilitate improved customer service by these banks. Some of the factors which inhibit the rapid growth of the ATMs are absence of a shared payments network, the high cost of ATM cards and machines and poor telecommunication infrastructure.

2.90 Economic integration within and across countries, deregulation, advances in telecommunications, and the growth of the Internet and wireless communication technologies are dramatically changing the structure and nature of financial services. Notwithstanding the rudimentary stage of internet banking in India, in order to promote safety and soundness for e-banking activities, as a precautionary measure, the Reserve Bank constituted a Working Group on Internet Banking and issued guidelines to the banks (Box II.3).

2.91 Priority sector lending⁴ continued to be an important aspect of lending to agriculture, small scale industries, transport operators, etc. Bank group-wise credit extended to these sectors is discussed below. Sector-wise breakup of priority sector advances of public sector banks are detailed in Appendix Table II.14. Bank-wise details of advances to agriculture and weaker sections as well as NPAs arising out of advances to weaker sections are furnished in Appendix Table II.15 (A) and (B).

2.92 The outstanding priority sector advances of PSBs increased by 14.7 per cent to Rs.1,46,546 crore as on the last reporting Friday of March 2001. At this level, the advances formed 43.0 per cent of the net bank credit (NBC) as on last reporting Friday of March 2001. Total agricultural advances of PSBs increased by Rs. 7,495 crore to Rs.53,685 crore as on the last reporting Friday of March 2001 comprising 15.7 per cent of NBC.

2.93 The total priority sector advances extended by private sector banks as on the last reporting Friday of March 2001 amounted to Rs.21,550 crore (constituting 38.2 per cent of NBC) as compared with Rs.18,019 crore a year ago. The share of small scale industries was the highest at 14.4 per cent of NBC, followed by advances to 'other priority sector' (14.2 per cent) and agriculture (9.6 per cent) (Appendix Table II.16). Bank-wise details of advances to priority sector, agriculture and weaker sections as well as NPAs arising out of advances to weaker sections are furnished in Appendix Table II.17 (A) and (B).

With the growing spread of internet and the forays being made by banks in the field of internet banking, the Reserve Bank of India had constituted a Working Group to examine the different issues relating to internet banking and recommend technology, security, legal and operational standards keeping in view international best practices. The terms of reference of the Working Group were related to the examination of different aspects of internet banking from regulatory and supervisory perspective and to recommend appropriate standards for adoption in India. In its report, the Working Group has classified the internet banking products into 3 types, based on the levels of access granted, which are detailed below:

General-purpose information like interest rates, branch locations, product features, FAQs, loan and deposit calculations etc., are provided on the bank’s website. There exist facilities for downloading various types of application forms. The communication is normally done through e-mail. There is no interaction between the bank's application systems and the customer. No identification or authentication of customers is done. In this case, the possibility of any hacking or an unauthorised person getting into the production system of the bank through the internet does not exist.

These systems provide customer-specific information in the form of account balances, transaction details, statement of accounts, etc. The information is still largely of the 'read only' format. Identification and authentication of the customer is through password. The information is fetched from the bank's application systems either in batch mode or off-line. In this case also, the application systems cannot be directly accessed through the internet.

These systems allow bi-directional transactional capabilities. Transactions can be submitted by the customers for on-line update. These systems require high degree of security and control. In such an environment, web server and the application systems are linked over secure infrastructure, which comprise the basic requirements in terms of technology covering computerisation, networking and security; inter-bank payment gateway and legal infrastructure for introduction of internet banking involving a fully Electronic Transactional System.

The recommendations cover the risks associated with internet banking, the technology and security standards for internet banking, legal issues relating to this new type of activity and the regulatory and supervisory concerns of the central bank. The recommendations of the Group have been accepted and the Reserve Bank has issued necessary guidelines to banks for implementation in a phased manner.

Reserve Bank of India (2001), 'Report of the Working Group on Internet Banking in India' June.

2.94 The foreign banks operating in India have to allocate a target of 32 per cent of NBC for the priority sector with sub-sectoral targets of 10 per cent of NBC for SSI and 12 per cent of NBC for exports. The foreign banks' lending to the priority sector as on the last reporting Friday of March 2001 constituted 34 per cent of NBC, with loans to exports (20.0 per cent of NBC) increasing to Rs. 6,863 crore in March 2001 from Rs.6,372 crore in March 2000 ( Appendix Table II.18)

2.95 The total outstanding advances to weaker sections provided by PSBs increased by Rs.3,660 crore over the level prevailing in March 2000 to Rs. 24,805 crore (7.3 per cent of NBC) as on the last reporting Friday of March 2001.

2.96 The outstanding advances of PSBs under the DRI scheme as at end-March 2001 formed 0.12 per cent of the total advances as at end-March 2000.

2.97 PSBs were advised to prepare Special Agricultural Credit Plans for increasing the credit flow to agriculture on an annual basis. During 2000-01, the disbursements to agriculture under this Plan were Rs.24,654 crore as against the projection of Rs.25,893 crore. During 2001-02, the target for disbursements has been set at Rs.30,818 crore.

2.98 The Swarnjayanti Gram Swarozgar Yojana (SGSY), a restructured poverty alleviation programme launched by the Government of India from April 1999, has subsumed IRDP and its allied schemes viz., Training of Rural Youth for Self Employment (TRYSEM), Development of Women and Children in Rural Areas (DWCRA), Supply of Improved Toolkits to Rural Artisans (SITRA), Ganga Kalyan Yojana (GKY) and Million Wells Scheme (MWS). The scheme aims at establishing a large number of micro enterprises in the rural areas of the country. SGSY is a holistic programme covering all aspects of self-employment such as organisation of the poor into Self Help Groups, training, credit, technology, infrastructure and marketing. During 2000-01, beneficiaries under the scheme number about 10.3 lakh (as at end- March 2001). Bank credit to the tune of Rs. 1,44,510 lakh along with Government subsidy amounting to Rs. 69,472 lakh were disbursed.

2.99 As at end of March 31, 2001, Lead Bank Scheme covered 576 districts in the country. During November 2000, three new States viz., Jharkhand, Uttaranchal and Chhattisgarh have been created by bifurcation of the existing states of Bihar, Uttar Pradesh and Madhya Pradesh, respectively. Consequent upon creation of the above states, the SLBC convenorship of all the six states (new as well as existing) has been assigned to some of the public sector banks by the Central Government in consultation with the Reserve Bank.

2.100 The position of the Indian banking system and its regulation and supervision vis-à-vis the principles laid down by the Basel Committee on Banking Supervision was assessed by the Advisory Group on Banking Supervision (Chairman: Shri M.S.Verma). The Group submitted its Report in May 2001. The major recommendations of the Group are detailed in Box II.4.

2.101 As part of new initiatives, new supervisory reporting system called DSB-O returns was introduced from the quarter ended June 2000, replacing the RALOO returns. The DSB-O returns consists of a set of seven returns showing the quarter-wise data on assets and liabilities, off-balance sheet exposure, inter-branch and inter-bank reconciliation, structural liquidity, problem credits and investments, large exposures, country exposure, profitability and frauds. The detailed analysis of DSB-O returns carried out by the Reserve Bank brought to light the various parameters of the performance of overseas branches. The supervisory concerns that emerged out of these analyses were communicated to the banks for necessary corrective action. Based on the analyses of DSB-O returns as also reports on portfolio appraisals on the functioning of foreign branches, the Reserve Bank held meetings with the individual banks to discuss the performance of their foreign branches, problems faced by them and strategic plans for the near future. The Reserve Bank received quarterly reports from the banks on the overseas sectors detailing changes in the regulatory framework, pending issues relating to both host country and home country supervision, business environment and perception of new opportunities, credit and control areas and compliance of audit/ inspection. Significant developments were noted and monitored.

The Advisory Group on Banking Supervision (Chairman: Shri M.S. Verma) sought to: (i) study the present status of applicability and relevance and compliance in India of the relevant standards and codes; (ii) study the feasibility of compliance and the time-frame within which this can be achieved given the prevailing legal and institutional practices in India; (iii) compare the levels of adherence in India vis-à-vis industrialised countries and also emerging economies particularly to understand India's position and to prioritise actions on some of the more important codes and standards; and (iv) chalk out a course of action for achieving the best practices.

The recommendations of the Group can broadly be classified under seven broad categories, viz., (i) Corporate Governance; (ii) Internal Control; (iii) Risk Management; (iv) Loan Accounting; (v) Transparency and disclosures; (vi) Financial Conglomerates; and (vii) Cross-border Banking Supervision.

With regard to the current status in India, the Group was of the view that, given the level of complexity and development of the Indian banking sector, the level of compliance with the standards and codes is of a high order. Wherever there are significant gaps, these can be remedied within a reasonable time-frame and, as such, are not causes for immediate concern provided that necessary amendments to laws, wherever required, are put in place without delay.

Given the predominantly public sector character of the banking sector, the Group felt that the nature of a bank's ownership should not be a critical factor affecting the type and quality of corporate governance. The quality of corporate governance should be the same in all types of banking organisations, irrespective of their ownership.

In the short run, it needs to be ensured that the directors on the boards of banks are conversant with complex issues such as risk management that banks need to tackle and that they are not over-committed elsewhere. While setting accountability standards for bank boards, the Group felt that there was a need for enhanced transparency and disclosures in respect of various aspects of boards' constitution and functioning.

The quality of MIS is an area of potential risk both from the point of view of internal control and regulatory oversight. It would, therefore, be necessary to strengthen the MIS and data collection machinery in banks to ensure integrity and reliability of data. This is also necessary for banks to move towards more sophisticated means of managing the risks inherent in their functioning.

The Group recommended greater orientation of the banks' managements and their boards towards a better understanding of risks and their management. Further more, in the view of the Group, it was desirable that some of the more capable and better-equipped banks could take the lead in expediting the process of transition from elementary levels of risk management to levels of greater sophistication and act as forerunners so that they could act as models for other banks to follow.

Over a period of time, the formulae-based system of classification of assets and provisioning will have to give way to a more realistic assessment of the realisability of assets, relying on a risk assessment-based system. However, a system of provisioning based on risk assessment as regards the realisability of a debt and the value of collaterals can take root only if the present lacunae in the relevant legal provisions and the system itself, which make it debtor-friendly, are removed.

At present, all banks irrespective of their size, scope and complexity of operations, are required to make the same credit risk disclosures. There is need for introducing the concept of materiality in the matter of disclosures. Among other things, banks should be asked to disclose qualitative information on their credit risk management and control policies and practices in the Management's 'Notes to the balance sheet'. Banks should also be advised to disclose information about significant concentrations of credit risk, business segment-wise general and specific provisions, movement in provisions and cumulative provisions held against impaired assets. There is also need for disclosures on transactions with affiliated and related parties and large shareholders.

Boards of most banks, particularly public sector banks would need to undergo an attitudinal change towards the operational risks faced by banks, that they have a better and firmer say in the maintenance and improvement of internal control systems in the banks. In-depth discussions on periodic reports on internal controls systems of banks between the management and their boards should be institutionalised. The Reserve Bank may consider taking steps, so that on-site inspections are individualised and more bank-specific in its approach. The Reserve Bank may also consider leveraging the findings/reports of the external auditors of banks by even engaging them for specific area audit/inspection of banks and utilise their reports for supervisory oversight as is done by some other regulators.

The Reserve Bank should ensure that fitness, propriety or other qualification tests can be applied to managers and directors of other unregulated entities in a conglomerate if there is any possibility of their exercising a material or controlling influence on the operations of regulated entities. It would be desirable to put in place arrangements for applying fitness, qualification and propriety tests on all shareholders with shareholdings beyond a specified threshold. Suitable legal provisions would need to be introduced in the Banking Regulation Act, in order to empower the Reserve Bank in this regard.

In order to ensure co-ordination amongst the supervisors of the different entities in the conglomerate, introduction of the concept of 'primary supervisor' may be considered. Designating one of the supervisors as the primary supervisor will substantially improve much needed coordination between different supervisors (regulators) and adds to the scope and quality of the overall supervision of the conglomerate.

Provision of unhindered and unqualified access to information to the home supervisor may be made a condition for permitting a bank to open offices abroad. Country-wise analyses will have to be made to ensure reciprocity between home and host supervisors in sharing information on certain qualitative aspects of the business undertaken by branches and subsidiaries of banking organisations outside the jurisdiction of their respective home supervisors.

Effective supervision of financial conglomerates, which would become a part of the banking sector in the near future, would require that supervisory coordination is based on formal arrangements which may include appointment of separate coordinators and, where considered necessary, primary regulators, for each group. The methods of supervision would have to become increasingly risk-based with greater reliance on the Boards of banks themselves and the external auditors. Supervision which moves along this direction would pave the way for a healthy and sound banking system.

Reserve Bank of India (2001), ‘Report of the Advisory Group on Banking Supervision’, June

2.102 During the calendar year 2000, commercial banks reported 3,072 cases of frauds involving an amount of Rs. 672.59 crore. Eight cases of frauds involving an amount of Rs.1.59 crore were reported by the banks in their overseas branches during the same period. These cases were followed up with the banks for necessary remedial measures and fixing staff accountability. During the year 2000-01 (July-June), 48 Caution Advices were issued to commercial banks/financial institutions in respect of firms/companies observed to have committed serious irregularities in their borrowal accounts. During the year 2000-01, 94 cases of robberies/ dacoities involving an amount of Rs. 3.44 crore were reported by public sector banks.

1 Banking Statistical Returns (BSR)