Principle

Indian Position

Remarks

I. Preconditions for effective Banking Supervision

Principle 1. An effective system of banking supervision will have clear cut responsibilities and objectives for each agency involved in the supervision of banks. Each such agency should possess operational independence and adequate resources. A suitable legal framework for banking supervision is also necessary including provisions relating to authorisation of banking establishments and their ongoing supervision; powers to address compliance with laws as well as safety and soundness concerns; and legal protection for supervisors. Arrangements for sharing information between supervisors and protection for confidentiality of such information, should be in place.

1(1): An effective system of banking supervision will have clear responsibilities and objectives for each agency involved in the supervision of banks.

(i) Laws are in place for banking, and for (each of) the agency (agencies) involved in banking supervision. The responsibilities and objectives of each of the agencies are clearly defined.

The RBI (RBI), which was formed under an act of parliament, viz., the Reserve Bank of India Act, 1934 (RBI Act), has the sole responsibility of supervision and regulation of banks in India. The Banking Regulation Act, 1949 (BR Act), lays down the law relating to banking regulation and supervision.

(ii) The laws and/or supporting regulations provide a framework of minimum prudential standards that banks must meet.

The laws supporting regulation and the guidelines and prudential norms issued by RBI from time to time provide a framework of minimum prudential standards that banks must meet. While by and large the prudential norms conform to the international standards, in some cases considering the special circumstances prevalent in the Indian banking system, RBI has permitted some deviations from the international benchmarks. These deviations are being reviewed regularly and where considered desirable a movement towards achieving these benchmarks on a time bound basis is being made.

(iii) There is a defined mechanism for coordinating actions between agencies responsible for banking supervision, and evidence that it is used in practice.

Supervision of commercial banks (other than RRBs) is the sole responsibility of RBI.

(iv) The supervisor participates in deciding when and how to effect the orderly resolution of a problem bank situation (which could include closure, or assisting in restructuring, or merger with a stronger institution).

The RBI Act and the BR Act provide for participation of RBI in deciding when and how to effect resolution of a problem bank situation. However, its interventions have often been impeded because of the present provisions of law requiring the courts and Central Government’s intervention.

(v) Banking laws are updated as necessary to ensure that they remain effective and relevant to changing industry and regulatory practices.

The banking laws are reviewed and updated from time to time considering the changing needs of the banking industry and the economy.

(i) The supervisory agency sets out objectives, and is subject to regular review of its performance against its responsibilities and objectives through a transparent reporting and assessment process.

RBI’s objectives as a supervisory agency is set out in the RBI Act and BR Act. The Department of Banking Supervision of RBI submits half-yearly and annual review notes on its performance to the Board for Financial Supervision (BFS) and the Central Board of RBI. An annual report on the working of RBI with detailed analysis of its annual accounts and an assessment of Indian economy is also submitted to the Central Government under Section 53(2) of the RBI Act. The system is transparent.

(ii) The supervisory agency ensures that information on the financial strength and performance of the industry under its jurisdiction is publicly available.

RBI ensures that information on financial strength and performance of the industry under its jurisdiction is publicly available. It produces and publishes, besides its Annual Report, a Report on Trend and Progress of Banking in India and several other reports and statistics on a periodical basis which provide information on the performance and strength of the banking industry.

1(2) Each such agency should possess operational independence and adequate resources

(i) There is, in practice, no significant evidence of government or industry interference in the operational independence of each agency, and/or in each agency’s ability to obtain and deploy the resources needed to carry out its mandate.

The RBI Act provides for operational independence to RBI. The Central Government, however, reserves the right to issue directions to RBI from time to time in public interest. There is no indication of industry interference in its functioning and it suffers from no limitation in obtaining and deploying the resources needed for carrying out its mandate.

(ii) The supervisory agency and its staff have credibility based on their professionalism and integrity.

This is adequately ensured.

(iii) Each agency is financed in a manner that does not unduly undermine its autonomy or independence and permits it to conduct effective supervision and oversight. This includes, inter alia:

• salary scales that allow it to attract and retain qualified staff;
• the ability to hire outside experts to deal with special situations;
• a training budget and program that provides regular training opportunities for staff;
• a budget for computers and other equipment sufficient to equip its staff with tools needed to review the banking industry; and
• a travel budget that allows appropriate on-site work.

RBI is so constituted and financed that its autonomy and independence are not undermined. It conducts effective supervision and oversight without facing any limitations and is able to raise the required resources therefor.

(i) The head of each agency is appointed for a minimum term and can be removed from office during such term only for reasons specified in law.

The Governor of RBI is appointed by the Central Government for a term not exceeding five years and is eligible for reappointment. The Central Government has powers to remove the Governor as per Section 11(1) of the RBI Act which does not provide for any reasons for removal.

(ii) Where the head of an agency is removed from office, the reasons must be publicly disclosed.

The present Act does not specify the reasons for which the Governor can be removed. The law also does not place any obligation on the government to make the reasons for removal public.

In the interest of proper perception of RBI’s independence and the independence of the office of the Governor/ Deputy Governors, it would be desirable to consider suitable amendments to the relevant provisions of law.

1 (3): A suitable legal framework for banking supervision is also necessary, including provisions relating to authorisation of banking establishments and their ongoing supervision.

(i) The law identifies the authority (or authorities) responsible for granting and withdrawing banking licences.

The powers to issue licence to a company for carrying on the business of banking (Section 22(1) of the BR Act) and the powers to revoke licence (Section 22(4) of the BR Act) are veste40d with RBI.

(ii) The law empowers the supervisor to set prudential rules administratively (without changing laws).

RBI is vested with powers to issue directions/ guidelines on any aspect of banking vide Section 35A of the BR Act.

(iii) The law empowers the supervisor to require information from the banks in the form and frequency it deems necessary.

Section 27 of the BR Act vests powers in RBI to call for any information from banking companies in the form and frequency it deems necessary.

1 (4): A suitable legal framework for banking supervision is also necessary, including powers to address compliance with laws as well as safety and soundness concerns.

(i) The law enables the supervisor to address compliance with laws and the safety and soundness of the banks under its supervision.

The BR Act vests powers in RBI to ensure compliance with its provisions. Non- compliance with mandatory guidelines can invite monetary and/or non-monetary penalties (Sections 46 to 48 of the BR Act).

(ii) The law permits the supervisor to apply qualitative judgement in forming this opinion.

Sections 35 and 22 of the BR Act provide for unrestricted access to RBI to all the records of a bank. RBI is free to apply qualitative judgement in forming its opinion about safety and soundness of a bank under its supervision.

(iii) The supervisor has unfettered access to banks’ files in order to review compliance with internal rules and limits as well as external laws and regulations.

The BR Act provides for unrestricted access to RBI to all the records of a bank.

(iv) When, in a supervisor’s judgement, a bank is not complying with laws and regulations, or it is or is likely to be engaged in unsafe or unsound practices, the law empowers the supervisor to:

• take (and/or require a bank to take) prompt remedial action.
• impose a range of sanctions (including the revocation of the banking licence).

RBI has powers to issue directions to banks in general or particular under section 35A of the Act in the public interest; or in the interest of banking policy; or to prevent the affairs of any banking company being conducted in a manner detrimental to the interests of the depositors or in a manner prejudicial to the interests of the banking company; or to secure the proper management of any banking company generally. It has powers to impose a range of sanctions. However, the power to revoke licence of a bank is subject to government concurrence.

1 (5): A suitable legal framework for banking supervision is also necessary, including legal protection for supervisors.

(i) The law provides legal protection to the supervisory agency and its staff against lawsuits for actions taken while discharging their duties in good faith.

The BR Act provides for explicit protection to the supervisors under Section 54. No suit or other legal proceeding shall lie against RBI or any of its officers for anything done in good faith or in pursuance of the BR Act.

(ii) The supervisory agency and its staff are adequately protected against the costs of defending their actions while discharging their duties.

The cost of legal action arising out of the discharge of official duties is met by RBI.

1(6): Arrangements for sharing information between supervisors and protecting the confidentiality of such information should be in place.

(i) There is a system of cooperation and information sharing between all domestic agencies with responsibility for the soundness of the financial system.

Information sharing between domestic regulatory bodies like Securities and Exchange Board of India (SEBI), National Bank for Agriculture and Rural Development (NABARD), National Housing Bank (NHB), etc., are attended to on the basis of mutual understanding. RBI is also represented on the boards of these bodies. A High Level Committee on Capital Markets comprising of Governor of RBI, Chairman of SEBI and Finance Secretary of the Central Government serves as a forum for discussing key regulatory issues of common interest.

(ii) There is a system of cooperation and information sharing with foreign agencies that have supervisory responsibilities for banking operations of material interest to the domestic supervisor.

RBI shares information with overseas supervisors based on reciprocity. However, RBI has not been seeking much information from home country supervisors of banks operating in India. A comprehensive assessment of the system of cooperation and information sharing is give in Chapter 8 of the report and in the relative Annexes 13 to 16.

(iii) The supervisor:

• may provide confidential information to another financial sector supervisor;

• is required to take reasonable steps to ensure that any confidential information released to another supervisor will be treated as confidential by the receiving party;

• is required to take reasonable steps to ensure that any confidential information released to another supervisor will be used only for supervisory purposes.

RBI does exchange confidential information with domestic and foreign supervisory authorities on reciprocal basis and with clear understanding that the information will remain confidential and will be used for the purpose for which it is sought. The law does not prohibit such exchange.

Maintenance of confidentiality is a precondition for release of information to other agencies. However, there is no legal requirement or any other mandatory provision requiring RBI to take reasonable steps to ensure that any confidential information released to other supervisors will be treated as confidential by the receiving party.

The information is shared subject to a condition that it shall be used only for the purpose for which it has been sought. However, this is not required due to any provision of law.

(iv) The supervisor is able to deny any demand (other than a court order or mandate from a legislative body) for confidential information in its possession.

The law provides such protection to RBI.

II. Licensing and Structure

Principle 2: The permissible activities of institutions that are licensed and subject to supervision as banks must be clearly defined, and the use of the word "bank" in names should be controlled as far as possible.

The term "bank" is clearly defined in law or regulations.

The term banking company is clearly defined in Section 5 (c) of the BR Act.

(i) The permissible activities of institutions that are licensed and subject to supervision as banks are clearly defined either by supervisors, or in laws or regulations.

The permissible activities of a banking company are clearly defined and listed in Section 6(1) of the BR Act.

(ii) The use of the word "bank" and any derivations such as "banking" in a name are limited to licensed and supervised institutions in all circumstances where the general public otherwise might be misled.

Section 7 of the BR Act limits the use of words such as "bank", "banker", or "banking" to a banking company only as part of its name or in connection with its business. No company can carry on the business of banking in India unless it uses as part of its name at least one of such words.

(iii) The taking of proper bank deposits from the public is reserved for institutions that are licensed and subject to supervision.

Institutions, which can undertake such activity are licensed and supervised by RBI.

Principle 3: The licensing authority must have the right to set criteria and reject applications for establishments that do not meet the standards set. The licensing process, at a minimum, should consist of an assessment of the banking organisation’s ownership structure, directors and senior management, its operating plan and internal controls, and its projected financial condition, including its capital base; where the proposed owner or parent organisation is a foreign bank, the prior consent of its home country supervisor should be obtained.

(i) The licensing authority has the right to set criteria for licensing banks. These may be based on criteria set in law or regulation.

The criteria for licensing are set out in Section 22(3) of the BR Act. RBI has also set prudential norms including norms for capital adequacy, which are followed, in licensing banks.

(ii) The criteria for issuing licences are consistent with those applied in ongoing supervision

The criteria for issuing licences laid down in the BR Act are consistent with major objectives of ongoing supervision.

(iii) The licensing authority has the right to reject applications if the criteria are not fulfilled or if the information provided is inadequate.

RBI has powers to reject an application for grant of licence if requisite criteria are not fulfilled or if the information provided is not adequate.

(iv) The licensing authority determines that the proposed legal and managerial structures of the bank will not hinder effective supervision.

As per Section 22 (3c) of the BR Act, general character of the proposed management is evaluated to ensure that it will not be prejudicial to the interests of present or future depositors.

(v) The licensing authority determines the suitability of major shareholders, transparency of ownership structure and source of initial capital.

The position is already obtaining.

(vi) A minimum initial capital amount is stipulated for all banks.

Section 22(3) (d) of the BR Act provides for ensuring adequacy of capital structure before grant of licence. Minimum requirement for paid-up capital and reserves and transfer to reserve fund have also been prescribed in the Act. Minimum assigned capital required to be brought in by a foreign bank has also been prescribed. However, while the minimum capital requirement laid down in the BR Act prescribes the start-up capital requirements for new private sector banks or foreign banks, it does not contain any enabling provision for RBI to decide capital of banks on case to case basis.

Although it has been considered so far that the powers available with RBI to prescribe and vary capital adequacy are sufficient to keep control on the initial capital brought and subsequently maintained by banks, it is felt that its powers to decide requirement of capital on case by case basis should be clearly defined in law.

(vii) The licensing authority evaluates proposed directors and senior management as to expertise and integrity (fit and proper test). The fit and proper criteria include; (1) skills and experience in relevant financial operations commensurate with the intended activities of the bank and (2) no record of criminal activities or adverse regulatory judgements that make a person unfit to uphold important positions in a bank.

Fit and proper test is applied to evaluate the directors and senior management.

At present RBI does not conduct a strict evaluation of the directors’ skill and experience in relevant activities which banks undertake. The acceptability of a director is evaluated more in general terms based on a proforma statement provided by the applicant bank. It is felt that RBI should be applying stricter norms for the ‘fit and proper’ test it applies to evaluate the directors so that the quality of the boards of banks is controlled better.

(viii) The licensing authority reviews the proposed strategic and operating plan of the bank. This includes determining that an appropriate system of corporate governance will be in place.

The operating plans and control and future expansion plans are reviewed with a view to ensuring that the business strategy of banks is sound and that the board is largely professionally managed. Suitable guidelines and prudential norms issued from time to time are also in place to ensure continued surveillance over the bank and its board. The functioning of board and its committees and adequacy of controls exercised by head office of banks over their branches and other offices is evaluated and rated as part of CAMELS rating done during on-site inspections.

(ix) The operational structure is required to include, inter alia, adequate operational policies and procedures, internal control procedures and appropriate oversight of the bank’s various activities. The operational structure is required to reflect the scope and degree of sophistication of the proposed activities of the bank.

Operational structure of banks is examined as part of licensing process.

(x) The licensing authority reviews pro forma financial statements and projections for the proposed bank. This includes an assessment of the adequacy of the financial strength to support the proposed strategic plan as well as financial information on the principal shareholders of the bank.

Projected financial statements are obtained for three years to study viability of the proposed strategic plan. Financial strength of promoters is evaluated.

The present pre-licensing review of the operational structure of an applicant for banking license is rather brief. At a time when complexity of bank products is growing and the delivery is increasingly becoming multi-channel, operational risks are increasing. RBI may, therefore, adopt a more detailed and stricter approach while reviewing the operational structure of a proposed bank (License applicant). Banks seeking license should be asked to state in detail their operational standards and procedures, internal control procedures and arrangements facilitating oversight of banks’ various activities by the supervisor.

(xi) If the licensing authority and the supervisory authority are not the same, the supervisor has the legal right to have its views considered on each specific application.

RBI is both the licensing as well as the supervising authority.

(xii) In the case of foreign banks establishing a branch or subsidiary, prior consent (or a statement of "no objection") of the home country supervisor is obtained.

RBI insists on prior consent of the home country regulator.

(xiii) If the licensing, or supervisory authority determines that the licence was knowingly based on false information, the licence can be revoked

RBI can cancel the licence of a bank if the banking company ceases to carry on banking business in India; or it fails to comply with any of the conditions imposed under Section 22(1), Section 22(3) or Section 22(3A). As per common law, any consent obtained through misrepresentation of facts is no consent. On this basis also, RBI can revoke the licence of a banking company that is obtained based on false information.

(i) The assessment of the application includes the ability of the shareholders to supply additional financial support, if needed

Yes.

(ii) At least one of the directors must have a sound knowledge of each of the types of financial activities the bank intends to pursue.

By virtue of Section 10A(2) of the B R Act, not less than 51 per cent of the total number of members of the Board of Directors of a banking company should have special knowledge or practical experience in accountancy, agriculture, banking, co-operation, economics, finance, law, small scale industry, etc.

While generally the position appears to be in order, with the changing market for financial products and technology, a greater stress is required on professionalism and expertise of the board members. It would, therefore, be preferable to stipulate clearly that boards should have at least one director with a sound knowledge of each type of financial activity the bank intends to pursue. Particular areas are risk management, transfer pricing, etc.

(iii) The licensing authority has procedures in place to monitor the progress of new entrants in meeting their business and strategic goals, and to determine that supervisory requirements outlined in the licence approval are being met.

The compliance with conditions imposed on new banking companies is monitored through quarterly system of on-site supervision till annual financial inspection commences. The required procedures are thus in place.

Principle 4: Banking supervisors must have the authority to review and reject any proposals to transfer significant ownership or controlling in existing banks to other parties

(i) Law or regulation contains a clear definition of "significant" ownership.

Substantial interest is defined in law. The BR Act contains the definition of substantial interest.

The definition provided in Section 5(ne) of the Banking Regulation Act appears to be fixing the threshold for substantial interest rather low. This may have to be re-examined.

(ii) There are requirements to obtain supervisory approval or provide immediate notification of proposed changes that would result in a change in ownership or the exercise of voting rights over a particular threshold or change in controlling interest.

There is no specific provision in law requiring obtention of prior supervisory approval for proposed change in ownership or exercise of voting rights over a threshold.

The position in this regard is not quite satisfactory and is open to controversy. Specific legal provision should therefore be made to rectify the situation.

(iii) The supervisor has the authority to reject any proposal for a change in significant ownership or controlling interest, or prevent the exercise of voting rights in respect of such investments, if they do not meet criteria comparable to those used for approving new banks.

RBI has requisite powers to reject/prevent any proposal for a change in significant ownership or controlling interest in a bank. This power too is derived from RBI’s general powers to issue directions under Section 35A of the Banking Regulation Act.

--Do--

(i) Supervisors obtain from banks, either through periodic reporting or on-site examinations, the names and holdings of all significant shareholders, including, if possible, the identities of beneficial owners of shares being held by custodians.

RBI receives a half-yearly return on ‘ownership and control’ from all domestic banks. The return contains details of top ten shareholders. Any significant change in ownership is also examined during onsite inspection.

Similar provisions would need to be put in place also in respect of foreign banks operating in India.

Principle 5: Banking supervisors must have the authority to establish criteria for reviewing major acquisitions or investments by a bank and ensuring that corporate affiliations or structures do not expose the bank to undue risks or hinder effective supervision.

(i) Laws or regulations clearly define what types and amounts (absolute and/or in relation to a bank’s capital) of acquisitions and investments need supervisory approval.

Formation of subsidiaries by banks requires prior approval of RBI. Banks are allowed to set up subsidiaries or make significant investment only in companies that are undertaking business authorised under Section 19(1) of the B R Act. Suitable ceilings for investments in subsidiaries and for acquisition both in relation to banks’ own capital and that of the investee company have been prescribed.

(ii) Laws or regulations provide criteria by which to judge individual proposals.

RBI examines viability of the proposed subsidiary or acquisition before granting permission.

(iii) Consistent with the licensing requirements, among the objective criteria that the supervisor uses is that any new acquisitions and investments do not expose the bank to undue risks or hinder effective supervision. The supervisor determines that the bank has, from the outset, adequate financial and organisational resources to handle the acquisition/investment

All major acquisitions are looked into from the point of view of their impact on the bank and its ability to manage the investment/ acquisition well.

(iv) Laws or regulations clearly define for which cases notification after the acquisition or investment is sufficient. Such cases should primarily refer to activities closely related to banking and the investment being small relative to the bank’s capital

Laws and regulations clearly define the extent to which investment/ acquisition can be made without the prior approval of the supervisor. Beyond that limit, however, save in clearly stated exceptions, no investments/ acquisitions are permissible in law.

III. Prudential Regulations and Requirements

Principle 6: Banking supervisor must set minimum capital adequacy requirements for banks that reflect the risks that the bank undertakes, and must define the components of capital, bearing in mind its ability to absorb losses. For internationally active banks, these requirements must not be less than those established in the Basel Capital Accord.

(i) Laws or regulations require all banks to calculate and consistently maintain a minimum capital adequacy ratio. At least for internationally active banks, the definition of capital, method of calculation and the ratio required are not lower than those established in the Basel Capital Accord.

This position obtains.

(ii) The required capital ratio reflects the risk profile of individual banks, in particular credit risk and market risk. Both on balance sheet and off-balance-sheet risks are included

Bank-specific capital ratios have not yet been introduced. However, market risk has been introduced for investment positions, foreign exchange open position and for open position in gold/silver/platinum. Both off- and on-balance sheet risks are included.

As advanced risk management systems are introduced and get stabilised in banks in the next 2/3 years, RBI should gradually move towards setting bank specific capital ratios based on the risk profile of individual banks.

(iii) Laws or regulations, or the supervisor, define the components of capital, ensuring that emphasis is given to those elements of capital available to absorb losses.

The components of capital have been defined as per Basel norms.

(iv) Capital adequacy ratios are calculated and applied on a consolidated bank basis.

The line of business of subsidiaries is different resulting in varied capital prescriptions being made by respective regulatory agencies. As such, CAR is calculated on solo basis. However, under prudential regulations of the central bank, any equity investment in subsidiaries is required to be deducted from Tier I capital of the parent bank.

(v) Laws or regulations clearly give the supervisor authority to take measures should a bank fall below the minimum capital ratio.

The BR Act vests powers in RBI to initiate action for non-compliance of any of its directions/regulations including non-adherence to capital ratios. RBI is also working on prompt corrective actions, which will be triggered in certain circumstances, one of which is fall in CRAR below specified limits.

RBI is constrained in its measures against banks which fail to meet the requirements in respect to capital adequacy largely because of their government ownership. Where the bank is owned by the government, RBI has shown forbearance in view of implied government guarantee. Such forbearance cannot be long term and specific measures against banks failing to meet the capital adequacy requirement need to be stipulated in the interest of overall soundness of the system.

(vi) Regular (at least semi-annually) reporting by banks to the supervisor is required on capital ratios and their components.

Compliance with CRAR is monitored through quarterly prudential reporting and on-site inspection of banks.

(i) For domestic, as well as internationally active banks, the definition of capital is broadly consistent with the Basel Capital Accord.

The position obtains.

(ii) The supervisor clearly sets out the actions to be taken if capital falls below the minimum standards.

At present, RBI has not set out any specific course of action in the case of banks whose capital falls below the minimum standards. Such cases are reviewed periodically by the BFS on individual basis. However, RBI is now in the process of devising a framework for Prompt Corrective Action based on triggers such as fall in capital adequacy ratio or increase in non-performing loans beyond a level.

(iii) The supervisor determines that banks have an internal process for assessing their overall capital adequacy in relation to their risk profile.

Risk-adjusted ratio for individual grouping of on- and off-balance sheet assets for arriving at capital adequacy ratio at the end of each quarter is prescribed by RBI. It is computed and reported by banks in detail to RBI as part of off-site return on capital adequacy.

(iv) Capital adequacy requirements take into account the conditions under which the banking system operates. Consequently, minimum requirements may be higher than the Basel Accord.

Banks are at present assessing their capital adequacy in the light of standard risk weights for assets as advised by RBI. They are, however, not yet attuned to assess capital adequacy in relation to their individual risk profile. This can take place only after advanced risk management systems are introduced and get stabilised in all banks.

RBI may assist and guide banks in their efforts to stabilise advanced risk management systems. It should encourage the larger and more capable banks to complete the process early so that they can act as leaders and models for the smaller and not so well equipped banks. Only by continuous encouragement and regulatory pressure will the system, as a whole, be able to improve its risk management systems and raise it to international standards.

(v) Capital adequacy ratios are calculated on both a consolidated and a solo basis for the banking entities within a banking group.

CRAR is, at present, calculated on solo basis only. However, any equity investment of a bank in subsidiaries is deducted from its Tier I capital.

(vi) Laws or regulations stipulate a minimum absolute amount of capital for banks.

Minimum requirement for paid-up capital and reserves and transfer to reserve fund are prescribed in Sections 11, 12 and 17 of the BR Act. However, these minima which were specified in law more than five decades back are now outdated. RBI has prescribed a minimum capital for new private sector banks, which is insisted upon at the time of licensing. Existing banks, which do not fulfil the criteria for new banks, are also being advised to raise their capital to that level.

Principle 7: An essential part of any supervisory system is the independent evaluation of a bank’s policies, practices and procedures related to the granting of loans and making of investments and the ongoing management of the loan and investment portfolios.

(i) The supervisor requires, and periodically verifies, that prudent credit-granting and investment criteria, policies, practices, and procedures are approved, implemented, and periodically reviewed by bank management and boards of directors.

This is currently available.

(ii) The supervisor requires, and periodically verifies, that such policies, practices and procedures include the establishment of an appropriate and properly controlled credit risk environment, including:

• a sound and well-documented credit granting and investment process;
• the maintenance of an appropriate credit administration, measurement and ongoing monitoring/ reporting process (including asset grading/ classification); and
• ensuring adequate controls over credit risk.

In the course of on-site examination, adequacy of credit and investment policies and adherence thereto are looked into.

Banks in India are yet to acquire adequate expertise on sophisticated credit risk mitigation techniques. Until banks improve their expertise, properly controlled credit risk environment will not be established. RBI has to guide the banks in these regards and enable them to enhance their expertise.

(iii) The supervisor requires, and periodically verifies, that banks make credit decisions free of conflicting interests, on an arm’s length basis, and free from inappropriate pressure from outside parties.

There are laws, and banks’ internal as well as supervisory guidelines to ensure that credit decisions are made free of conflicting interests, on arms length basis and free from inappropriate pressures from outside parties.

(iv) The supervisor requires that a bank’s credit assessment and granting standards are communicated to, at a minimum, all personnel involved in credit granting activities.

This practice is followed by banks at present.

(v) The supervisor has full access to information in the credit and investment portfolios and to the lending officers of the bank.

Yes. It is available.

(i) The supervisor requires that the credit policy prescribes that major credits or investments, exceeding a certain amount or percentage of the bank’s capital, are to be decided at a high managerial level of the bank. The same applies to credits or investments that are especially risky or otherwise not in line with the mainstream of the bank’s activities.

Banks generally follow a well laid out loan policy and have a structure for delegation of discretionary powers at different managerial levels under which credits are sanctioned or investments are made.

(ii) The supervisor requires that banks have management information systems that provide essential details on the condition of the loan and investment portfolios.

Credit monitoring systems are in place in all banks. However, in the case of quite a few banks the adequacy of MIS can be questioned. In the light of recent developments in information technology, there is need and scope for improvement in credit-related MIS at banks.

(iii) The supervisor verifies that bank management monitors the total indebtedness of entities to which they extend credit.

This is being done.

Principle 8: Banking supervisors must be satisfied that banks establish and adhere to adequate policies, practices and procedures for evaluating the quality of assets and the adequacy of loan loss provisions and reserves.

(i) Either laws or regulations, or the supervisor, sets rules for the periodic review by banks of their individual credits, asset classification and provisioning, or the law/regulations establish a general framework and require banks to formulate specific policies for dealing with problem credits.

RBI has laid down detailed guidelines on income recognition, asset classification and provisioning covering both on- and off-balance sheet exposures in line with international standards. The guidelines specify quarterly review of asset classification, income recognition and provisioning requirements.

(ii) The classification and provisioning policies of a bank and their implementation are regularly reviewed by the supervisor or external auditors.

This is being done. The system of on-site inspection comprises of appraisal of asset quality and the impairment to asset values. The quality of assets is also monitored on quarterly basis through off-site monitoring returns.

(iii) The system for classification and provisioning includes off-balance-sheet exposures.

The system of classification and provisioning include only such off-balance sheet items that are likely to get converted into on-balance sheet items.

Off-balance sheet items should receive more attention than at present. Like funded exposures, these should also be classified and a note to that effect should be provided in banks’ financial statements.

(iv) The supervisor determines that banks have appropriate policies and procedures to ensure that loan loss provisions and write-offs reflect realistic repayment expectations.

RBI has determined the asset classification and provisioning norms and no discretion is left to the management of banks. Loss items have to be provided for in full. In case a bank chooses to write off, the compromise/ settlement should be as per the policy laid down by the board of the bank.

The supervisor has prescribed provisioning norms in accordance with which loan loss provisions are required to be made. Because of the existence of prescribed norms, banks do not generally undertake an independent exercise for assessment of loan loss provisions and requirement of write-off. Banks have not developed sophisticated models and statistical tools for assessment of provisioning requirement that would reflect realistic repayment expectations. They are however moving towards that and once they acquire the expertise, the supervisor will no more be required to give structured provisioning norms.

(v) The supervisor determines that banks have appropriate procedures and organisational resources for the ongoing oversight of problem credits and for collecting past due loans.

Loan recovery policies of banks are studied during on-site inspections to assess adequacy of procedures and organisational set-up to recover past due loans.

(vi) The supervisor has the authority to require a bank to strengthen its lending practices, credit-granting standards, level of provisions and reserves, and overall financial strength if it deems the level of problem assets to be of concern.

RBI has powers to give banks specific directions for ensuring adequacy of provisions under section 35A of the BR Act. RBI impresses upon banks to reduce exposure to certain sectors, if found excessive, and improve quality of credit appraisal, if found lacking.

(vii) The supervisor is informed on a periodic basis, and in relevant detail, concerning the classification of credits and assets and of provisioning.

Quarterly detailed reporting of asset classification and provisioning is in place. Details in respect of top 30 non-performing loans such as balance outstanding, provisions held thereagainst and interest in arrears are called for and analysed.

(viii) The supervisor requires banks to have mechanisms in place for continually assessing the strength of guarantees and appraising the worth of collateral.

There are general instructions for periodic evaluation of the worth of collaterals including guarantees. However, practices followed in this regard are not uniform.

There is wide scope for improving the assessment of guarantees and worth of collaterals. Banks have to enhance their capabilities in this regard. RBI may also consider issuing suitable detailed instructions to banks in this regard.

(ix) Loans are required to be classified as impaired when there is reason to believe that principal and/or interest will not be paid according to the original loan agreement.

This practice is being followed. Loans are being classified as impaired even if the default in payment of principal/interest is less than two quarters.

(x) The valuation of collateral is required to reflect the net realisable value.

See remarks against (viii) above.

(i) Loans are required to be classified as non-performing when payments are contractually a minimum number of days in arrears (e.g. 30, 60, 90 days). Refinancing of loans that would otherwise fall into arrears does not lead to improved classifications for such loans.

A credit facility is classified as non-performing if interest and instalments of principal remain unpaid for two quarters after it has become past due. Rules regarding refinancing of loans that would otherwise fall into arrears are quite stringent. In any case, the regulator does not permit improved classification of loans, which escape falling into arrears due to refinancing.

(ii) The supervisor requires that valuation, classification and provisioning for large credits are conducted on an individual item basis.

Asset classification and provisioning exercise is done account-wise.

Principle 9 : Banking supervisors must be satisfied that banks have management information systems that enable management to identify concentrations within the portfolio and supervisors must set prudential limits to restrict bank exposures to single borrowers or groups of related borrowers

(i) A "closely related group" is explicitly defined to reflect actual risk exposure. The supervisor has discretion, which may be prescribed by law, in interpreting this definition on a case-by-case basis.

As per RBI guidelines of July and November 1991, the guiding principle in identification of a group is commonality of management and effective control. The term ‘under same management’ is defined in Companies Act. RBI has the discretion to interpret the definition on a case by case basis.

The stress in the Basel paper is on unchallenged authority of the supervisor. Instead of relying on implied powers, RBI should have powers in terms of explicit legal provisions. In a globalised market and while dealing with global entities, situations are likely to arise when such explicit legal provisions would be necessary for it to act decisively.

(ii) or regulations, or the supervisor, set prudent limits on large exposures to a single borrower or closely related group of borrowers. "Exposure" include all claims and transactions, on balance sheet as well as off-balance sheet.

Prudential exposure norms have been prescribed both in respect of operations of foreign branches as well as for domestic lending to individual/group borrowers at 25/50 per cent of banks’ capital funds. Prudential exposure includes off-balance sheet exposure as well, which carries 50 per cent weight.

(iii) The supervisor verifies that banks have management information systems that enable management to identify on a timely basis concentrations (including large individual exposures) within the portfolio on a solo and consolidated basis.

The MIS of banks enables concentration to be identified on solo, group and industry levels. The supervisor examines such concentrations through periodic returns received from banks as well as at the time of on-site inspection.

(iv) The supervisor verifies that bank management monitors these limits and that they are not exceeded on a solo and consolidated basis.

A half-yearly reporting to management of banks on the exposure ceilings on solo as well as group basis is in place. The supervisor also monitors this exposure.

(v) The supervisor regularly obtains information that enables concentrations within a bank’s credit portfolio, including sectoral and geographic exposures, to be reviewed.

This arrangement is in place. RBI compiles and publishes basic statistics bank-wise and group-wise on sectoral and geographic concentration of credit.

(i) Bank’s are required to adhere to the following definitions:

-10 percent or more of a bank’s capital is defined as a large exposure;

-25 percent of a bank’s capital is the limit for an individual large exposure to a private sector non-bank borrower or a closely related group of borrowers.

-Minor deviations from these limits may be acceptable, especially if explicitly temporary or related to very small.

An exposure of 15 per cent and above of bank’s capital funds is treated as large credit. Banks are required to adhere to prudential exposure limit of 25 per cent for individual borrowers and 50 per cent for groups of borrowers.

Principle 10: In order to prevent abuses arising from connected lending, banking supervisors must have in place requirements that banks lend to related companies and individuals on an arm’s length basis, that such extensions of credit are effectively monitored, and that other appropriate steps are taken to control or mitigate the risks.

(i) A comprehensive definition of "connected or related parties" exists in law and/or regulation. The supervisor has discretion, which may be prescribed in law, to make judgements about the existence of connections between the bank and other parties.

There are guidelines from RBI on connected lendings. These, however, do not fully cover all such lendings which may be deemed as connected.

A comprehensive definition of ‘connected’ or ‘related parties’ and ‘large shareholdings’ needs to be provided by law/ regulator.

(ii) Laws and regulations exist that exposures to connected or related parties may not be extended on more favourable terms (i.e., for credit assessment, tenor, interest rates, amortisation schedules, requirement for collateral) than corresponding loans to non-related counterparties.

Section 20 of the BR Act prohibits lending to directors and certain other related parties in order to check unethical practices of granting loans and advances to relatives of directors of banks, directors of other banks and/or their relatives. These restrictions do not apply to loans and advances to the members of the Local Advisory Boards of foreign banks. However, aggregate of such loans and advances should not exceed 5 per cent of a bank’s advances in India. As regards loans to related companies, i.e., banks’ own subsidiaries or joint ventures, banks are required to maintain arms length relationship and sanction of such loans and advances is subject to procedures applicable to sanction of loans and advances to directors of other banks and their relatives. The subsidiary company is treated as any other company and all loans to such companies have to be made at commercial rates and are subject to limits that apply to similar companies. Sanction of loans and advances to senior officers of a bank and their relatives should ordinarily be by next higher sanctioning authority and the same should be reported to the board. The above norms equally apply to award of contracts.

While there are guidelines given by RBI in regard to connected lendings, the approach of banks in following the guidelines is not uniform. RBI requires to make its follow-up of this aspect of banks’ lending stricter so that the risks related to such exposures are clearly understood and managed.

(iii) The supervisor requires that transactions with connected or related parties exceeding specified amounts or otherwise posing special risks are subject to approval by the bank’s board of directors.

RBI has issued guidelines that loans aggregating Rs. 25.00 lakh and above should be invariably approved by the boards of banks. Loans for less than Rs. 25.00 lakh could be sanctioned by competent authorities as per delegation of powers, but should be reported to the board.

(iv) The supervisor requires that banks have procedures in place to prevent persons benefiting from the loan being part of the preparation of the loan assessment or of the decision itself

Banks normally have procedures in place to prevent persons benefiting from the loan being associated either with its appraisal or sanction. However, there is no clear cut requirement to this effect stipulated by the supervisor excepting in regard to the directors.

RBI may consider issuing specific instructions in this regard.

(v) Laws or regulations set, or the supervisor has the mandate to set on a general or case-by-case basis, limits for loans to connected and related parties, to deduct such lending from capital when assessing capital adequacy or to require collateralisation of such loans.

Laws or regulations do not set any limit on a general or case to case basis for loans to connected and related parties. There is also no clear-cut mandate with the supervisor to do so. While investments in subsidiaries are deducted from Tier I capital, this is not so in the case of loans and advances sanctioned to connected parties. Loans to subsidiaries should be sanctioned on 'arms length' principle basis, i.e., subject to commercial judgement.

Since the principle is that loans to connected and related parties are given on commercial basis maintaining an arms length relationship, these are not considered deductible from banks’ capital. In the interest of maintaining discipline, both in respect of credit sanction and capital adequacy, RBI may consider issuing instructions that such loans, if not fully collateralised, may be deducted from banks’ capital to the extent they are not collateralised.

(vi) The supervisor requires banks to have information systems to identify individual loans to connected and related parties as well as the total amount of such loans, and to monitor them through an independent credit administration process.

While there are informal systems in banks which identify connected and related parties, loans at individual unit and group levels, the total amount of such loans is not generally kept in focus. Very few banks have independent credit administration process for such loans.

RBI should stipulate a stricter control and monitoring over such loans by banks. Banks should be instructed to monitor the total amount of such loans and introduce an independent credit administration process.

(vii) The supervisor obtains and reviews information on aggregate lending to connected and related parties.

As above.

As above.

(i) The definition of "connected or related parties" established in law and/or regulation is broad and, generally, includes affiliated companies, significant shareholders, board members, senior management, key staff as well as close family members, corresponding persons in affiliated companies, and companies controlled by insiders and shareholders.

The term "connected lendings" includes directors of banks, firms /companies in which he is interested and individuals to whom director is a guarantor or partner, senior management and their relatives, directors of subsidiaries/trustees of mutual funds/venture capital funds established by banks and other banks.

The definition of connected or related parties should be made more broad based to ensure that all kinds of connected or related party lendings can be brought under its purview. This aspect of banks’ lending has not been in focus largely because of their public sector character. With increasing privatisation these would assume criticality and the supervisor should have adequate mechanism to supervise and regulate this effectively.

(ii) There are limits on aggregate exposures to connected and related parties that are at least as strict as those for single borrowers, groups or related borrowers.

There are at present no limits on aggregate exposures to connected and related parties by a bank.

Such a limit needs to be established.

Principle 11: Banking supervisors must be satisfied that banks have adequate policies and procedures for identifying, monitoring and controlling country risk and transfer risk in their international lending and investment activities, and for maintaining appropriate reserves against such risk

(i) The supervisor determines that a bank’s policies and procedures give due regard to the identification, monitoring and control of country risk and transfer risk. Exposures are identified and monitored on an individual country basis (in addition to the end-borrower/end-counterparty basis). Banks are required to monitor and evaluate developments in country risk and in transfer risk and apply appropriate countermeasures.

Indian banks having overseas operations are required to lay down internal guidelines on country and counterparty risk management and fix limits based on risk rating of the country. In the normal course, prudential exposure norms apply to all loans and investments overseas including loans to sovereign entities. RBI has issued detailed guidelines on risk management, wherein banks have been advised to classify countries into low risk, moderate risk and high risk considering country ratings given by international rating agencies. The exposure to each country will be monitored at least on a weekly basis till banks are equipped to monitor exposures on real time basis. However, banks have been advised to evaluate all exposures to problem countries on a real time basis.

(ii) The supervisor verifies that banks have information systems, risk management systems and internal control systems to comply with those policies.

Adequacy of banks’ policies on country and counterparty risk identification, measurement and control are assessed during on-site inspection.

(iii) There is supervisory oversight of the setting of appropriate provisions against country risk and transfer risk. There are different international practices that are all acceptable as long as they lead to reasonable, risk-related, results.

While banks keep track of and have exposure limits for counterparty and country risks, sophisticated risk management systems are yet to be put in place by most Indian banks. Provisioning against country risks and transfer risks is not quite scientific and may not bear right relationship with the fluctuating levels of such risks.

RBI may assist banks in hastening introduction of more scientific and sophisticated risk management systems. Banks have already worked with the guidelines provided by RBI for more than two years and should now be able to move faster to higher levels and sophistication in risk management.

(iv) These include, inter alia:

• The supervisor (or some other official authority) decides on appropriate minimum provisioning by setting fixed percentage for exposures to each country.
• The supervisor (or some other official authority) sets percentage intervals for each country and the banks may decide, within these intervals, which provisioning to apply for the individual exposures.
• The bank itself (or some other body such as the national bankers’ association) sets percentage or guidelines or even decides for each individual loan on the appropriate provisioning.
• The provisioning will then be judged by the external auditor and/or by the supervisor.

There are no guidelines from the supervisor regarding any fixed percentage of provisioning for exposure to each country. Banks take their own decisions, the adequacy of which is assessed by independent auditors. The arrangement, however, being bank-specific is to a large extent subjective and does not reflect the exposure risk of the system to country risks and transfer risks.

RBI may consider setting fixed percentage for exposures to each country until banks are in a position to assess and provide for such risks on objective and scientific basis.

(v) The supervisor obtains and reviews sufficient information on a timely basis on the country risk/transfer risk of individual banks.

Information on country risk is monitored through a quarterly return on country-wise and counterparty-wise exposure. RBI collates information on exposure to countries where there are restrictions on exchange remittance and also advises banks from time to time not to undertake further exposures on problem countries.

Principle 12: Banking supervisors must be satisfied that banks have in place systems that accurately measure, monitor and adequately control market risks; supervisors should have powers to impose specific limits and/or a specific capital charge on market risk exposures, if warranted.

(i) The supervisor determines that a bank has suitable policies and procedures related to the identification, measuring, monitoring and control of market risk.

A risk management oriented approach to supervision has been adopted by RBI in the last two years, i.e., since April 1999. Banks, however, as yet do not have in place highly developed and sophisticated risk management systems notwithstanding the fact that risk identification, measurement and mitigation is being attempted on a more systematic basis.

The process has to be expedited.

(ii) The supervisor determines that the bank has set appropriate limits for various market risks, including their foreign exchange business.

Banks have been advised to set internal limits on various market risks like liquidity risk, interest rate risk and foreign exchange risk.

(iii) The supervisor has the power to impose a specific capital charge and/or specific limits on market risk exposures, including their foreign exchange business.

RBI has general powers under Section 35A of the BR Act to issue directions to banks on any issue of concern.

(iv) The supervisor verifies that banks have information systems, risk management systems and internal control systems to comply with those policies, and verifies that any limits (either internal or imposed by the supervisor) are adhered to.

These aspects are looked into during on-site examination.

(v) The supervisor satisfies itself that there are systems and controls in place to ensure that all transactions are captured on a timely basis, and that the banks’ positions are revalued frequently, using reliable and prudent market data.

Banks are required to ensure segregation of front office, middle office and back office functions. Banks revalue their foreign exchange portfolios on a monthly basis. The investments are valued quarterly.

(vi) The supervisor determines that banks perform scenario analysis, stress testing and contingency planning, as appropriate, and periodic validation or testing of the systems used to measure market risk.

Although these aspects of risk management are covered by RBI guidelines on the subject, these do not form part of commonly followed practices by all banks at present.

Two years since RBI brought out its detailed guidelines on risk management would have given adequate time to banks to restructure their MIS to the requirement of risk management systems and stabilise their systems. It is time now that banks are required to move forward and adopt the practice of performing scenario analysis, stress testing, contingency planning and periodic validation of the systems used to measure market risks. These capabilities must be in place in all banks latest by the end of the financial year 2002-2003. RBI may consider directing banks towards that goal.

(vii) The supervisor has the expertise needed to monitor the actual level of complexity in the market activities of banks.

RBI has the requisite skills and has arrangements in place to ensure continuous upgradation of these skills.

(i) Either through on-site work, or through independent external experts, the supervisor determines that senior management understands the market risks inherent in the business lines/ products traded and that it regularly reviews and understands the implications (and limitations) of the risk management information that they receives.

Adequacy of risk management organisational structure, policies and procedures and adherence to the limits set are verified by RBI during on-site inspection. On these occasions, RBI’s inspection teams also take a view on the senior management’s appreciation of the risk scenario for banks and alert them wherever it finds it necessary.

Whereas a discussion with the senior management of banks is held by the RBI on-site inspection team by exception, such discussions should be made compulsory to ensure the senior management’s full understanding of the risk situation. This will also help quicker stabilisation of risk management systems in banks.

(ii) The supervisor reviews the quality of management information and forms an opinion on whether the management information is sufficient to reflect properly the banks’ position and exposure to market risk. In particular, the supervisor reviews the assumptions management has used in their stress testing scenarios, and the banks’ contingency plans for dealing with such conditions.

Quality of management information system is assessed during on-site inspection.

(iii) The supervisor who does not have access to the adequate skills and capacity does not allow banks to determine their regulatory capital requirements based on sophisticated models, such as VaR.

RBI has the requisite skill to ensure that a model or any other risk management mechanism used by any of the banks supervised by it is not beyond its own understanding.

Principle 13: Banking supervisors must be satisfied that banks have in place a comprehensive risk management process (including appropriate board and senior management oversight) to identify, measure, monitor and control all other material risks and, where appropriate, to hold capital against their risks.

(i) The supervisor requires individual banks to have in place comprehensive risk management processes to identify, measure, monitor and control material risks. These processes are adequate for the size and nature of the activities of the bank and are periodically adjusted in light of the changing risk profile of the bank and external market developments. These processes include appropriate board and senior management oversight.

RBI has issued detailed guidelines to banks for putting in place effective Asset Liability Management systems. Every bank has an Asset Liability Management Committee (ALCO), headed by the Chief Executive Officer/Chairman and Managing Director or the Executive Director. Banks are required to lay down policy on identification, measurement, monitoring and control of various kinds of risks such as liquidity risk, interest rate risk and currency risk and to review the policy from time to time to incorporate changes in business environment and the perception of the top management about the risks.

(ii) The supervisor determines that the risk management processes address liquidity risk, interest rate risk, and operational risk as well as all other risks, including those risks covered in other Principles (e.g., credit and market risk). These would include:

• Liquidity: good management information systems, central liquidity control, analysis of net funding requirements under alternative scenarios, diversification of funding sources, stress testing and contingency planning. Liquidity management should separately address domestic and foreign currencies.

• Interest rate risk: good management information systems and stress testing.

• Operational risk: internal audit, procedures to counter fraud, sound business resumption plans, procedures covering major system modifications and preparation for significant changes in the business environment.

RBI has advised banks to monitor liquidity through maturity or cash flow mismatches. Future cash flows are to be bracketed in different time buckets. Banks are required to fix tolerance levels for various maturity mismatches depending upon their asset – liability profile, extent of stable deposit base, nature of cash flows, etc. To abide by the guidelines, banks have been advised to put in place adequate and efficient MIS.

Liquidity in foreign currencies is measured and monitored through quarterly Maturity and Positions statements in four major currencies (USD, GBP, EURO, JPY) and all other currencies where the turnover in a currency is in excess of 5 per cent of total foreign exchange turnover.

Banks are expected to measure interest rate risk through traditional gap analysis. Each bank is required to set prudential limits on gaps for each time bucket considering total assets, earning assets and equity. Banks may fix prudent level for earnings at Risk (EaR) or Net Interest Margin (NIM).

All banks have a system of internal audit. RBI has issued various guidelines on putting in place appropriate checks/procedures to prevent occurrence of frauds. Banks also have to report large value frauds of Rs 10 million and above immediately on occurrence/detection to RBI along with details of systems and human failures, staff involvement, action taken against those involved, etc. The above reporting is in addition to the regular quarterly reporting on all frauds for over Rs. 100,000.

Liquidity, interest rate and operational risk management in banks continue to be at the basic level. There is now an appreciation of the existence of these risks but lack of expertise for their proper management. MIS, in most cases, continues to be not fully aligned to the requirements of proper risk management with the consequence that advanced practices like stress testing and contingency planning are still not in place. The pace of improving risk management systems needs to be accelerated. A timeframe of two years from now, i.e., by the end of the year 2002-2003, should be feasible for banks to graduate to risk management systems which will enable them to adopt advanced risk management practices.

(iii) The supervisor issues standards related to such topics as liquidity risk, interest rate risk, foreign exchange risk and operational risk.

RBI has issued guidelines to manage liquidity risk, interest rate risk and currency risk. Banks have been advised to fix prudential internal limits for all kinds of risks.

(iv) The supervisor sets liquidity guidelines for banks, which include allowing only truly liquid assets to be treated as such, and takes into consideration undrawn commitments and other off-balance-sheet liabilities, as well as existing on-balance-sheet liabilities.

RBI has issued guidelines on management of liquidity based on residual maturity of assets, un-drawn commitments, and on- and off-balance sheet items. Liquid assets are clearly defined and only truly liquid assets are allowed to be treated as such.

(v) The supervisor determines that limits and procedures are communicated to the appropriate personnel and primary responsibility for adhering to limits and procedures is placed with the relevant business units.

Primary responsibility of adhering to laid down prudential limits and procedures rests with the relevant business units.

(vi) The supervisor periodically verifies that these risk management processes, capital requirements, liquidity guidelines and qualitative standards are being adhered to in practice.

RBI monitors the liquidity position of banks through a fortnightly return on structural liquidity. Banks are required to submit a monthly return on interest rate sensitivity for exposures in Rupee as well as foreign currencies to RBI. Besides off-site monitoring procedures, the annual on-site inspections ensure adherence to the set guidelines by banks.

(i) The supervisor has the authority to require a bank to hold capital against risks in addition to credit and market risk.

RBI has the authority to impose and vary capital requirement for a bank. It has, however, not adopted the practice of requiring banks to hold capital against risk other than credit and market risks.

While Indian banks are moving towards holding capital against credit and market risks, it would be a little premature at this stage to require them to hold capital against risks other than these.

(ii) The supervisor encourages banks to include a statement on their risk management policies and procedures in their publicly available accounts.

RBI does not at present require banks to include a statement on their risk management policies and procedures in their publicly available accounts.

We need to move towards this practice. However, since such a statement presupposes a clear understanding of the risk profile of bank by their top management and boards and a well defined policy and strategies for their management, any meaningful statement can be made only when adequate risk management systems are in place in all banks. RBI may therefore consider giving banks a timeframe within which this goal may be achieved. A timeframe of two years from now, i.e., end of the year 2002-2003, may be considered adequate for any preparation that may be needed to be made in this regard.

(iii) Supervisors obtain sufficient information to enable them to identify those institutions carrying out significant foreign currency liquidity transformation.

Banks are required to fix aggregate and individual gap limits for each currency with the approval of RBI. They are required to adopt Value at Risk approach to measure the risk associated with forward exposures. RBI monitors currency risk through a monthly return on maturity and positions for on- and off-balance sheet items in foreign exchange.

(iv) The supervisor determines that, where a bank conducts its business in multiple currencies, management understands and addresses the particular issues this involves. Foreign currency liquidity strategy is separately stress-tested and the results of such tests are a factor in determining the appropriateness of mismatches.

The top management is involved in fixing and monitoring of limits on foreign exchange positions. Stress testing of foreign currency liquidity for large banks active in foreign exchange market has been prescribed.

Principle 14: Banking supervisors must determine that banks have in place internal controls that are adequate for the nature and scale of their business. These should include clear arrangements for delegating authority and responsibility; separation of the functions that involve committing the bank, paying away its funds, and accounting for its assets and liabilities; reconciliation of these processes; safeguarding its assets; and appropriate independent internal or external audit and compliance functions to test adherence to these controls as well as applicable laws and regulations.

(i) Corporate or banking laws identify the responsibilities of the board of directors with respect to corporate governance principles to ensure that there is effective control over every aspect of risk management.

Corporate governance in banks and financial institutions has lately been receiving considerable attention. Recent amendments to the Companies Act addresses some major concerns about governance of these institutions. As per the new Section 292-A it would be mandatory for every public company having paid up capital of not less than Rs. 5 crore to constitute a Committee of the Board known as Audit Committee. The Annual Report of the Company shall disclose composition of the Audit Committee and the Audit Committee should have discussions with the auditors periodically about Internal Control Systems, the scope of audit including the observations of the auditors and review the half yearly and annual financial statements before their submission to the Board of Directors. This Committee has also been charged with the responsibility of ensuring compliance at the organisation-wide level with internal control systems.

RBI has laid clear stress on the setting up of risk management systems and in its guidelines given to banks in this regard, spelt out clearly that every bank’s board should articulate its risk management philosophy, policies and risk limits by assessing the banks’ risk bearing capacity. These guidelines further add that:

1. Board should review the progress in implementation of the guidelines at half yearly intervals.
2. Constitute an independent Risk Management Committee or Executive Committee for evaluating overall risk assumed by the bank.

While the role of the Audit Committee has evolved well over the past few years and will get defined even better in terms of the new Section 292-A in the recent amendments to the Companies Act, in banks and financial institutions, there needs to be a more specific focus on risk management. It is, therefore, recommended that risk management should be a specifically stipulated item for being covered in the director’s responsibility statement. The present laws relating to the responsibilities of the Board of Directors are mostly in general terms. These responsibilities should be made more specific with clearly identified focus. Greater stress should be laid on the responsibility of the board in exercising control over all aspects of risk management.

(ii) The supervisor determines that banks have in place internal controls that are adequate for the nature and scale of their business. These controls are the responsibility of the board of directors and deal with organisational structure, accounting procedures, checks and balances and the safeguarding of assets and investments. More specifically, these address:

• Organisational structure: definitions of duties and responsibilities including clear delegation of authority (for example, clear loan approval limits), decision-making procedures, separation of critical functions (for example, business origination, payments, reconciliation, risk management, accounting, audit and compliance).
• Accounting procedures: reconciliation of accounts, control lists, information for management.
• Checks and balances (or "four eyes principles"): segregation of duties, cross-checking, dual control of assets, double signatures.
• Safeguarding assets and investments: including physical control.

RBI has issued a number of instructions / guidelines to banks requiring them to streamline their inspection and audit machinery, monitor treasury operations, introduce concurrent audit, introduce internal control systems for prevention of frauds, monitor cash flows in accounts, promptly reconcile inter-branch accounts, etc. and balance books periodically. RBI has also issued guidelines from time to time on definition and segregation of duties and responsibilities for different areas of business. Checks and balances principle is fundamental to banking. Each bank is required to have a written policy on delegation of powers for managing credit, investments, money market operations, foreign exchange operations, etc. There are separate internal control guidelines covering forex transactions conformity to which is verified during on-site inspections by RBI.

(iii) To achieve a strong control environment, the supervisor requires that the board of directors and senior management of a bank understand the underlying risks in their business and are both committed to, and legally responsible for, the control environment. Consequently, the supervisor evaluates the composition of the board of directors and senior management to determine that they have the necessary skills for the size and nature of the activities of the bank and can address the changing risk profile of the bank and external market developments. The supervisor has the legal authority to require changes in the composition of the board and management in order to satisfy these criteria.

The Director’s Responsibility Statement as aforesaid aims at ensuring that the members of the boards of banks understand the underlying risks in banking business and are both committed to and legally responsible for control environment obtaining in the bank.

The supervisor has the legal authority to require changes in the composition of the board and management although these go into play very late in the deteriorating performance scenario of the bank. In this context, the real issue relates to the public sector banks in which the regulator has, at least in practice, very little say in composition and continuance of the board and/or the senior management even in persistently deteriorating performance scenario. The prerogative lies with the owner, i.e., the government, which it rarely exercises.

While, in the course of the on-site inspection of banks, some assessment is made of the boards’ and senior management’s performance, such assessments rarely result in measures being taken by the regulator for improvement/change even where a case for such improvement/change seems strong. This is presumably so because the constitution of the boards and appointment of top management remain in the hands of the government. It is, therefore, suggested that a more formal and rigorous assessment of the board’s performance be undertaken by the regulator. It is further suggested that the regulator should adopt rating of the board’s performance with the provision that if the rating falls below a certain level specified prompt corrective action should be triggered.

(iv) The supervisor determines that there is an appropriate balance in the skills and resources of the back office and control functions relative to the front office/business origination.

The regulator has issued clear guidelines governing internal control aspects of banks. At the time of on-site inspection, the supervisor ascertains whether the capacity of the back-office matches the activities of the front office/business organisation. Matching capabilities of back and front offices is an important test of the adequacy of internal control. Such matching obviously depends upon matched skills and resources which the supervisor ascertains.

(v) The supervisor determines that banks have an appropriate audit function charged with (a) ensuring that policies and procedures are complied with and (b) reviewing whether the existing policies, practises and controls remain sufficient and appropriate for the bank’s business. The supervisor determines that the audit function:

• has unfettered access to all the bank’s business lines and support departments;
• has appropriate independence, including reporting lines to the board of directors and status within the bank to ensure that senior management reacts to and acts upon its recommendations;
• has sufficient resources, and staff that are suitably trained and have relevant experience to understand and evaluate the business they are auditing;
• employs a methodology that identifies the key risks run by the bank and allocates its resources accordingly.

Each bank has an internal audit department that inspects the bank’s functioning periodically and reports to the Audit Committee. All exceptionally large branches (whose total deposits and advances are Rs. 100 crore and above) and large branches (whose total deposits and advances are Rs. 15 crore and above but below Rs. 100 crore) are subjected to concurrent audit so as to cover at least 50 per cent of banks’ business operations (total of deposits and advances). The treasury functions of banks, viz., investments, funds management including inter–bank borrowings, bill rediscounting and foreign exchange, are also subjected to mandatory concurrent audit.

Banks have sufficient resources and invest in training their staff to conduct internal inspections. They also avail of the training facilities offered by RBI for this purpose.

Additionally, many banks have also instituted separate "system audits" which focus on whether the internal procedures and controls are being adhered to at the operational level and whether the existing systems are adequate and commensurate with the requirement of the changing business environment.

As RBI itself is moving towards a "Risk-Based Supervision", individual bank audit functions would also now have to introduce appropriate modifications in their systems and MIS to meet the changing supervisory focus. Only a coordinated effort on the part of banks as well as RBI can result in a quick and smooth transition to "Risk-Based Supervision".

(vi) The supervisor has access to the reports of the audit function.

This position obtains. Extant RBI guidelines to its supervisors require them to have a comprehensive evaluation of audit function with reference to such reports.

(i) In those countries with a unicameral board structure (as opposed to a bicameral structure with a supervisory board and a management board), the supervisor requires the board of directors to include a number of experienced non-executive directors.

Though banks in India have a unicameral board structure, routine executive functions including sanctioning of credit are vested with management committees constituted from out of the board members, as in the case of Audit Committee of the Board. The board includes, at a minimum, 51 per cent members with practical experience or special knowledge in areas of accountancy, agriculture, banking, cooperation, economics, finance, law, small scale industry, etc.

(ii) The supervisor requires the internal audit function to report to an Audit Committee.

All audit reports are placed before the Audit Committees of banks for their perusal. In that sense, the audit function of banks reports to the Audit Committee of the board and the board itself. The board’s Audit Committee, however, does not exercise any administrative control over the audit function of the bank.

(iii) In those countries with a unicameral board structure, the supervisor requires the Audit Committee to include experienced non-executive directors.

This position obtains.

Principle 15: Banking supervisors must determine that banks have adequate policies, practices and procedures in place, including strict "know-your-customer" rules, that promote high ethical and professional standards in the financial sector and prevent the bank being used, intentionally or unintentionally, by criminal elements.

(i) The supervisor determines that banks have in place adequate policies, practices and procedures that promote high ethical and professional standards and prevent the bank from being used, intentionally or unintentionally, by criminal elements. This includes the prevention and detection of criminal activity or fraud, and reporting of such suspected activities to the appropriate authorities.

These issues receive the supervisor’s attention adequately. While banks have their individual policies about identification of customers and those acting on their behalf, the focus so far has been more on prevention of frauds against banks rather than money laundering. A specific law against money laundering is, however, expected to be enacted shortly.

(ii) The supervisor determines that banks have documented and enforced policies for identification of customers and those acting on their behalf as part of their anti-money-laundering program.

There are clear rules on what records must be kept on customer identification and individual transactions and the retention period.

The Draft Bill on Money Laundering makes it obligatory for every financial institution and intermediary to maintain a record of all transactions or series of interconnected transactions exceeding the value of Rs. 25 lakh in a month. They are required to furnish information on these transactions to the Commissioner of Income Tax having jurisdiction over such financial institutions or intermediaries. The financial institutions or intermediaries would also be required to verify and maintain the records of identity of all clients in the prescribed manner for five years from the date of cessation of transaction between the client and the financial institution. The enactment will adequately take care of the requirement.

(iii) The supervisor determines that banks have formal procedures to recognise potentially suspicious transactions. These might include additional authorisation for large cash (or similar) deposits or withdrawals and special procedures for unusual transactions

Banks have also been advised to be careful while dealing with clients who deposit and withdraw large sums of money in cash. Such transactions of Rs. 10 lakh and above are to be closely monitored. All banks have dual authorisation for transactions involving large sums. Definition of large sum is left to the discretion of banks. During on-site examination, large value transactions are looked into.

(iv) The supervisor determines that banks appoint a senior officer with explicit responsibility for ensuring that the bank’s policies and procedures are, at a minimum, in accordance with local statutory and regulatory anti-money laundering requirements

Anti-Money Laundering law is likely to be passed shortly. The relative bill is already before the Parliament. The regulatory requirements in these regards have also not been clearly defined.

With the passage of the bill, regulatory requirements matching therewith will also need to be put in place.

(v) The supervisor determines that banks have clear procedures, communicated to all personnel, for staff to report suspicious transactions to the dedicated senior officer responsible for anti-money laundering compliance.

No dedicated official for Anti-Money Laundering compliance is required to be designated.

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(vi) The supervisor determines that banks have established lines of communication both to management and to an internal security (guardian) function for reporting problems.

Existing instructions require banks to report all cases of frauds. Reporting of frauds, case by case, for more than Rs 100,000 is in place. Such frauds are reported to banks’ top management as well as to RBI under the reporting system prescribed by RBI. This vigilance function in banks coordinates with RBI as well as the Central Vigilance Commission (for government owned banks). RBI has advised banks to report frauds immediately to the concerned investigative agency particularly in respect of large value frauds.

(vii) In addition to reporting to the appropriate criminal authorities, banks report to the supervisor suspicious activities and incidents of fraud material to the safety, soundness or reputation of the bank.

Each fraud of above Rs. 100,000 is reported individually and frauds for Rs. 100,000 and below are reported in consolidated form. Banks are also required to report suspicious transactions to their controlling offices. Further, the draft Money Laundering Bill also has a provision requiring banks to report suspicious activities to the agency which will administer the Act.

(viii) Laws, regulations and/or banks’ policies ensure that a member of staff who reports suspicious transactions in good faith to the dedicated senior officer, internal security function, or directly to the relevant authority cannot be held liable.

There are extensive guidelines and internal service rules which provides necessary protection to legitimate reporting. Various statutes relating to government revenue collection, criminal procedure code and related laws also enable such reporting to the competent authority in confidence by a member of public.

(ix) The supervisor periodically checks that banks’ money laundering controls and their systems for preventing, identifying and reporting fraud are sufficient. The supervisor has adequate enforcement powers (regulatory and/or criminal prosecution) to take action against a bank that does not comply with its anti-money laundering obligations.

At the time of inspection, sample check is done of recently opened accounts with a view to seeing whether the prescribed 'Know Your Customer' instructions on account opening are being followed. RBI has the general powers to proceed against banks for violations of its regulations. So far, money laundering is sought to be discouraged by the different instructions issued by various departments of RBI and by Government of India. Now, a draft bill on Prevention of Money Laundering containing detailed guidelines and reporting system is in the final stages of legislation before the Indian Parliament.

(x) The supervisor is able, directly or indirectly, to share with domestic and foreign financial sector supervisory authorities information related to suspected or actual criminal activities.

Modus operandi of frauds reported to RBI is shared with banks operating in India so as to check repetition of similar frauds. In case of need or where the fraud may have cross-border ramifications, this data had been shared in the past with overseas supervisors.

(xi) The supervisor determines that banks have a policy statement on ethics and professional behaviour that is clearly communicated to all staff.

Banks have code of conduct for its staff and all staff members sign an undertaking to comply with code of conduct rules at the time of joining the bank.

(i) The laws and/or regulations embody international sound practices, such as compliance with the relevant forty Financial Action Task Force Recommendations issued in 1990 (revised 1996).

The Financial Action Task force (FATF) recommendations and other international best practices are taken into account while framing regulations on fraud and other abuse of banking system.

(ii) The supervisor determines that bank staff is adequately trained on money laundering detection and prevention.

The training process is expected to commence as soon as the Prevention of Money Laundering Bill gets enacted by the Parliament.

(iii) The supervisor has the legal obligation to inform the relevant criminal authorities of any suspicious transactions.

It is a well established convention under the Indian polity. RBI has specifically advised banks to immediately report all frauds and attempts to defraud banks to the concerned investigative agency besides informing RBI.

(iv) The supervisor is able, directly or indirectly, to share with relevant judicial authorities information related to suspected or actual criminal activities.

RBI shares such information, on specific request, with relevant judicial authorities.

(v) If not performed by another agency, the supervisor has in-house resources with specialist expertise on financial fraud and anti-money laundering obligations.

RBI has specialised expertise on financial fraud and also seconds its supervisors to the Central Bureau of Investigation to exchange experience and to gain and share relevant expertise.

IV. Methods of Ongoing Banking Supervision

Principle 16: An effective banking supervisory system should consist of some form of both on- site and off-site supervision.

(i) Banking supervision requires an in-depth understanding, periodic analysis and evaluation of individual banks, focussing on safety and soundness, based on meetings with management and a combination of both on-site and off-site supervision. The supervisor has a framework that (1) uses on-site work (conducted either by own staff or through the work of external auditors) as a primary tool to:

• provide independent verification that adequate corporate governance (including risk management and internal control systems) exists at individual banks;
• determine that information provided by banks is reliable;
• obtain additional information needed to assess the condition of the bank.

Over the past 4/5 years RBI has been changing its supervisory framework from a transaction based framework to a system-based framework. It has both on-site and off-site inputs. Accuracy and reliability of information is verified in the course of on-site inspection conducted by RBI officials. Since 1995, on-site inspections are based on CAMELS (Capital adequacy, Asset quality, Management, Earnings, Liquidity and Systems and controls) model and aim at evaluation of banks’ safety and soundness, appraisal of the quality of board and management, compliance with prudential regulations and analysis of key financial factors such as capital, earnings and liquidity to determine banks’ financial soundness and continued solvency. Independent verification of the corporate governance function is covered as part of management evaluation under the CAMELS based on-site inspection.

And (2) uses off-site work as a primary tool to :

• review and analyse the financial condition of individual banks using prudential reports, statistical returns and other appropriate information, including publicly available information;
• monitor trends and developments for the banking sector as a whole.

Financial condition of individual banks is reviewed on the basis of both off-site as well as on-site work. Pursuant to the new supervision strategy approved by the BFS, RBI has introduced a formal Supervisory Reporting System since 1995. Analysis of the returns is done for individual banks, peer groups and industry as a whole for various macroeconomic indicators. These analyses help in detecting early warning signals.

The supervisory returns and prudential reports called for from the commercial banks have to provide means for detecting early warning signals of weakening financial position, if any.

(ii) The supervisor checks for compliance with prudential regulations and other legal requirements through on-site and off-site work.

On-site inspection is also used to validate supervisory information received in the form of off-site returns. RBI verifies compliance with prudential regulations and legal requirements through annual on-site inspection and quarterly off-site supervisory returns.

(iii) The appropriate mix of on-site and off-site supervision is determined by the particular conditions and circumstances of the country. In any event, the framework integrates the two functions so as to maximise the synergy and avoid supervisory gaps.

Frequency of inspections is generally annual, which can be varied depending on the financial position, methods of operation and compliance record of the bank. For instance, weak banks are now under quarterly monitoring regime including on-site visits. Periodical on-site inspection system is supported by off-site monitoring, periodicity whereof could be increased depending on bank-specific conditions.

(i) The supervisor has procedures in place to assess the effectiveness of on-site and off-site functions, and to address any weaknesses that are identified.

The results of on-site inspections and off-site monitoring are put up to top management and BFS, which give directions. The directions may encompass the functioning and methodology of the supervisory process. The effectiveness of the Department of Banking Supervision of RBI is also reviewed.

(ii) The supervisor has the right to access copies of reports submitted to the board by both internal and external auditors.

The supervisor has access to all records of banks.

(iii) The supervisor has a methodology for determining and assessing the nature, importance and scope of the risks to which individual banks are exposed, including the business focus, the risk profile and the internal control environment. Off-site and on-site work is prioritised based on the results of that assessment.

Depending on supervisory concerns based on off-site supervisory returns, off-site and on-site work is prioritised. On-site inspection uses CAMELS based rating methodology. Off-site surveillance uses critical ratios and also does analysis around CAMELS, peer-group and sectoral benchmarks in arriving at early warning signals.

(iv) The supervisor is legally required to treat as confidential information received as part of the supervisory process. However, the supervisor is given powers under the law to disclose information in certain defined circumstances. The law prevents disclosure of confidential information unless the supervisor is satisfied that it will be held confidential by the recipient, or unless disclosure is otherwise required by law.

Any information collected by RBI during the course of supervisory process is kept confidential as per Section 45-E of the RBI Act. However, RBI has powers to disclose information in public interest in a consolidated form and in accordance with the practice and customary usage among bankers or as permitted by law.

(v) The supervisor is able to reasonably place reliance on internal audit work that has been competently and independently performed.

Each bank has an internal audit/inspection department. The effectiveness of internal audit work of banks is assessed during the course of on-site inspection. Supervisory concerns thrown up by internal audit/ inspection provide leads for on-site inspection. The supervisor is able to reasonably place reliance on internal audit work that has been performed by banks competently and independently.

Principle 17: Banking supervisors must have regular contact with bank management and a thorough understanding of the institution’s operations.

(i) Based on the risk profile of individual banks, the supervisor has a programme of regular meetings with senior and middle management (including the board, non-executive directors and heads of individual units) to discuss operational maters such as strategy, group structure, corporate governance, performance, capital adequacy, liquidity, asset quality, risk management systems etc.

Contact with banks is continuous. The findings of on-site inspection are discussed first by inspection teams with banks’ Chief Executive Officer. This is followed by a meeting of top management of RBI with banks’ management to discuss matters of supervisory concerns identified during on-site inspection. The overall CAMELS rating is communicated to banks’ management. Banks are consulted before introduction of major reporting changes and senior bank officers are associated with the working groups and committees set up by RBI to examine/deliberate on regulatory/supervisory issues.

In the meetings with banks, the supervisor as of now does not involve the non-executive directors. RBI may consider introducing this practice which can be expected to ensure better involvement of the entire board with the concerns of the regulator as also its assessment as regards the performance of the board.

(ii) The supervisor has a thorough understanding of the activities of its banks. This is accomplished through a combination of off-site surveillance, on-site reviews and regular meetings.

The supervisor has a thorough understanding of the activities of its banks accomplished through off-site and on-site surveillance mechanism at its disposal.

(iii) The supervisor requires banks to notify it of any substantive changes in their activities or any material adverse developments, including breach of legal and prudential requirements.

Such arrangements are in place.

(iv) As part of the licensing process, and on an on-going basis during routine supervision, the supervisor considers the quality of management.

Quality of management is one of the parameters considered to arrive at CAMELS rating of banks during on-site inspection. Quality of management also plays important role while granting and continuing license to banks.

Principle 18: Banking supervisors must have a means of collecting, reviewing and analysing prudential reports and statistical returns from banks on a solo and consolidated basis.

(i) The supervisor has the legal authority to require banking organisations to submit information, on both a solo and consolidated basis, on their financial condition and performance, at regular intervals. These reports provide data on matters such as on- and off-balance sheet assets and liabilities, profit and loss, capital adequacy, liquidity, large exposures, loan loss provisioning, market risk and deposit sources.

Under Section 27 of the B R Act, RBI has powers to call for any information at any time from a banking company relating to its affairs necessary for the purposes of the Act. Presently, RBI receives prudential reports and statistical returns from banks on a solo basis only. RBI receives quarterly/half-yearly/yearly statutory returns on various aspects like assets and liabilities, profitability, capital adequacy, large exposures, asset quality, connected lendings, maturity profile of foreign exchange positions and interest rate sensitivity for overseas operations. The statutory reporting on interest rate and liquidity risk pertaining to domestic operations have been introduced from the quarter ending June 1999. Recently, BFS has directed that banks should also be asked to submit reports on their subsidiaries covering capital adequacy, asset quality, large credits, profitability, and ownership and control to enable a consolidated view of banks to be taken.

(ii) Laws and regulations establish, or the supervisor has the authority to establish, the principles and norms regarding the consolidation of accounts as well as the accounting techniques to be used.

The system of drawing up the financial and operational results on a consolidated basis has not yet been introduced, as it is not yet required by law. BFS has decided not to insist on consolidation of accounts at present and instead to confine its role to taking a consolidated view of the activities of the group.

For consolidated supervision, consolidation of accounts of the supervised units would be essential. Steps need to be taken so that the necessary legal provisions are introduced and banks are required to prepare consolidated accounts.

(iii) The supervisor has a means of enforcing compliance with the requirements that the information be submitted on a timely and accurate basis. The supervisor determines that the appropriate level of senior management is responsible for the accuracy of supervisory returns, can impose penalties for deliberate mis-reporting and persistent errors, and can require that inaccurate information be amended.

Prudential returns are required to be signed by the Chief Executive Officer or a whole time director of banks to ensure high-level involvement. Any inconsistency or inaccuracy in reporting is taken up with the top management of the bank. Submission of any wrong information to RBI can invite imposition of penalties specified in Section 46(1) of the BR Act.

(iv) The information that is required to be submitted includes standardised prudential and statistical reports, and detailed balance sheets and income statements, as well as supporting schedules that provide details concerning on- and off-balance sheet activities and on reserves included in capital. Inclusion of data on loan classification and provisioning is also required.

The balance sheet format, and prudential and statistical reports are standardised. In addition to data on loan classification and provisioning, banks are required to report net non-performing loans ratio, provisions held and adequacy thereof. Off-site returns cover areas such as assets and liabilities, profitability, capital adequacy, large exposures, asset quality, connected lendings, ownership and control, maturity profile of foreign exchange positions, interest rate sensitivity for overseas and domestic operations and structural liquidity.

(v) The supervisor has the authority to request and receive any relevant information from banks, as well as any of their related companies, irrespective of their activities, where the supervisor believes that it is material to the financial situation of the bank or the assessment of the risks of the bank.

Section 27(2) of the BR Act provides for powers to call for information on any business or affairs with which the banking company is concerned. RBI is in a position to call for any information about related companies of banks through the concerned bank.

(vi) The supervisor has an analytical framework that uses the statistical and prudential information for the ongoing monitoring of the condition and performance of individual banks. The results are also used as a component of on-site supervision planning. This requires that the supervisor has an adequate information system.

Prudential and statistical returns are used to create database on each bank. The database helps in critical analysis bank-wise, peer group-wise and for the industry as a whole. First signal reports are generated peer group-wise, which throw up adverse selected financial indicators. Half-yearly review of performance of entire banking industry is also undertaken. Off-site analysis forms an important input for on-site inspection.

(vii) In order to make meaningful comparisons between banking organisations, the supervisor collects data from all banks and all other relevant entities within a banking organisation on a comparable basis and related to the same dates (stock data) and periods (flow data).

Supervisory data are called in a manner that it gives a clear picture of the supervised units on a comparable basis. The bases of the data collected are kept common so that peer group and industry-wise comparisons are possible.

(viii) The supervisor collects data from banks at a frequency (e.g., monthly, quarterly and annually) commensurate with the nature of the information requested, and the size, activities and risk profile of the individual bank.

RBI collects information on quarterly, half-yearly or annual basis commensurate with the nature of information that is sought. Frequency for submission of returns is same for all banks. However, as and when required, RBI can call for ad-hoc returns from specific banks for specified purposes.

Principle 19 : Banking supervisors must have a means of independent validation of supervisory information either through on-site examinations or use of external auditors.

(i) The supervisor has in place a coherent process for planning and executing on-site visits, using either in-house examiners, or making use of the work of external auditors, as appropriate. There are policies and procedures in place to ensure that examinations are conducted on a thorough and consistent basis with clear responsibilities, objectives and outputs. The supervisor holds meetings with banks and their auditors to discuss the results of work by the external auditors and to agree on the responsibilities for corrective work.

Examinations are conducted using in-house examiners and occasionally through chartered accountants for specific targeted appraisals. RBI has a manual containing planning process, responsibilities of examiners, objectives of examination and formats of reporting the output. Along with the corporate office, branches accounting for 50 per cent of advances of a public sector bank and 60 per cent of advances of a private sector bank and foreign bank, all ‘very large’, ‘exceptionally large’ and specialised branches conducting major lending business like industrial finance, corporate finance and international finance and branches with special problems noticed or categorised as ‘unsatisfactory’ by banks are covered. Besides, one third (subject to a maximum of 12 offices) of the total controlling offices is subjected to inspection. All annual financial inspections are conducted based on CAMELS pattern. RBI holds annual meetings with banks to discuss findings of the examination and suggest corrective steps to improve performance.

(ii) The supervisor has the authority to monitor the quality of work done by external auditors for supervisory purposes. The supervisor has the authority to directly appoint external auditors for conducting supervisory tasks or oppose the appointment of an external auditor that is deemed to have inappropriate expertise and/or independence.

The balance sheet and profit and loss account of banks are to be audited by qualified statutory auditors, whose appointment, reappointment and removal is subject to prior approval of RBI (Section 30 (1A) of the BR Act). Section 30 (1B) of the BR Act gives powers to RBI to appoint external auditors or direct the statutory auditors of a bank to conduct special audit.

(iii) The supervisor can also make use of external auditors to examine specific aspects of banks’ operations, provided there is a well developed, professionally independent auditing and accounting profession with skills to undertake the work required. The respective roles and responsibilities for the supervisor and the auditors in these circumstances are clearly defined by the supervisor.

The accounting profession in India is well established having been in place for 50 years. The Institute of Chartered Accountants of India (ICAI) is a self-regulatory organisation for the profession and RBI interacts with ICAI to discuss application of accounting standards. However, RBI does not generally use the services of external auditors for examination of specific aspects of banks’ operations.

RBI may consider using independent and well qualified external auditors to examine specific aspects of banks’ operations. Such specific reports, besides adding depth and quality to the on-site examination conducted by RBI, will also reduce its burden of having to conduct very extensive on-site inspections. Should RBI adopt this idea, it will have to clearly define its own role and responsibilities as against the external auditors who it will engage for looking into some specific aspects of banks’ operations.

(iv) The supervisor has the legal right of full access to all bank records for the furtherance of supervisory work. The supervisor also has similar access to the board, senior management and staff, when required.

Section 35(2) of the BR Act casts duty on every director, officer or employee of banks to produce all such records, accounts and other documents. Under Section 35(3) of the Act, an Inspecting Officer of RBI may examine on oath any director, officer or employee of a banking company in relation to its business.

(v) The supervisor has a programme for the periodic examination of supervisory returns by examiners or through the work of external auditors. There is a requirement that certain key supervisory returns such as that for capital adequacy be examined at least annually by the auditors and a report submitted to the supervisor.

Accuracy and reliability of supervisory returns are verified by in-house examiners of RBI during the course of annual financial inspection. The statutory auditors are at present required to verify the calculation of the net demand and time liabilities and maintenance of Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) by banks on sample basis. The auditors also certify the income recognition and asset classification procedures, capital adequacy calculations, etc.

(i) The supervisor meets with management and the board of directors each year to discuss the results of the supervisory examination or the external audit. Such visits should allow for the supervisor to meet separately with the independent board members.

The Principal Inspecting Officer of the RBI meets the Chief Executive Officer of the bank on conclusion of inspection to discuss the findings of on-site inspection. The top management of RBI meets the CEO of banks annually to discuss serious issues of concern thrown up by on-site inspections. The on-site reports are also discussed by the top management of RBI with the boards of banks in case major supervisory concerns are noticed.

The supervisor does not generally meet with the boards and external auditors of banks. RBI may consider introducing such meetings in the interest of greater involvement of the board with supervisory concerns and actions in order to enrich the scope of examination of banks.

(ii) The supervisor meets periodically with external audit firms to discuss issues of common interest relating to bank operations.

RBI does not generally meet with the external auditors of banks. They do not submit any report to RBI orally or in writing.

The practice of RBI meeting with external (statutory) auditors could be introduced. It is expected to result in considerable advantage to the system of examination of banks’ operations by RBI.

Principle 20: An essential element of banking supervision is the ability of the supervisors to supervise the banking group on a consolidated basis.

(i) The supervisor is aware of the overall structure of banking organisations (i.e., the bank and its subsidiaries) or groups and has an understanding of the activities of all material parts of these groups, including those that are supervised directly by other agencies.

The approach now adopted by BFS is to obtain a consolidated view of banks' operations without insisting on consolidation of accounts for the present. Supervision of subsidiaries will be left to the regulator of the subsidiary. However, in order to facilitate full consolidation when found necessary, amendments to the Act are being sought which will enable RBI to call for consolidation of accounts. Till then, banks will be asked to annex the accounts of their subsidiaries with their accounts to enable supervisors to take a consolidated view of their operations.

(ii) The supervisor has a supervisory framework that evaluates the risks that non-banking activities conducted by a bank or banking group may pose to the bank or banking group.

While conducting on-site inspections, the performance of subsidiaries and joint ventures is examined and any supervisory concern relating to their performance and control by parent bank are indicated in the report on the parent bank. In the past RBI has followed the practice of conducting inspection of merchant banking subsidiaries of banks. This was done based on the conditions imposed for such inspection at the time of licensing such subsidiaries. There is now a rethinking on inspections.

A complete disassociation of the RBI from supervision of merchant banking subsidiaries of banks may not be desirable. In the interest of a consolidated view of supervision, the regulator of the parent body (banks) should keep itself informed of the goings on in the subsidiary. Exchange of information with SEBI on these matters would be unavoidable.

(iii) The supervisor has the legal authority to review the overall activities of a bank, whether the activities are conducted directly (including those conducted at overseas offices), or indirectly, through subsidiaries and affiliates of the bank.

For the purpose of inspection, Section 35 of the BR Act defines 'banking company' to include all subsidiaries outside India and all branches inside and outside India. Subsidiaries in India are supervised by other agencies depending upon the nature of their activities. RBI has discontinued its inspection, leaving it to the concerned supervisory agency of these subsidiaries as they fall within the supervisory ambit of the capital markets regulator, the Securities and Exchange Board of India (SEBI).

(iv) There are no impediments to the direct or indirect supervision of all affiliates and subsidiaries of a banking organisation.

In the initial stages of formation of subsidiaries or affiliates, there were no other regulatory agencies in India to exercise control over such bank-affiliated entities. As the regulatory system evolved, Securities and Exchange Board of India, Insurance Regulatory and Development Authority, etc. have come into being. In the light of such developments, RBI has embarked on a review of the conditions governing the initial licensing of these subsidiaries and affiliates and rework the modalities for assessing the impact of these institutions on the parent bank. Taking into account the regulatory jurisdiction of other agencies, an arrangement is being worked out to evolve a problem redressal mechanism to deal with specific situations where a subsidiary's functioning can cause an impact on the parent bank.

(v) Laws or regulations establish, or the supervisor has the authority to impose, prudential standards on a consolidated basis for the banking organisation. The supervisor uses its authority to establish prudential standards on a consolidated basis to cover such areas as capital adequacy, large exposures and lending limits.

The regulators have the capabilities to impose prudential regulations on the respective entities falling under their jurisdiction. As the line of activity of the subsidiaries are different from the parent bank, like activity specific subsidiaries for housing, credit cards, factoring, asset management, software, etc., it was considered that it may not be feasible to impose prudential standards on a consolidated basis in India.

(vi) The supervisor collects consolidated financial information for each banking organisation.

Private sector banks are required to annex the balance sheet and profit and loss accounts to their annual reports. Public sector banks generally give a brief description of the performance of the bank’s subsidiaries and the group in Directors’ report that forms part of the annual accounts of banks. They are now required to annex the accounts of their subsidiaries also.

(vii) The supervisor has arrangements with functional regulators of individual business vehicles within the banking organisation group, if material, to receive information on the financial condition and adequacy of risk management and controls of such business vehicles.

Subsidiaries are supervised either by departments of RBI such as Department of Non-banking Supervision and Internal Debt Management Cell or by other agencies such as SEBI and NHB.

A formal framework for coordination between different regulators is essential. RBI may consider taking necessary steps to impress upon the government the need and urgency of achieving and maintaining a high level of coordination among different regulators.

(viii) The supervisor has the authority to limit or circumscribe the range of activities the consolidated banking group may conduct and the overseas locations in which activities can be conducted; the supervisor uses this authority to determine that the activities are properly supervised and that the safety and soundness of the banking organisation is not compromised.

This authority is being exercised through the parent bank.

(i) For those countries that allow corporate ownership of banking companies:

• the supervisor has the authority to review the activities of parent companies and of companies affiliated with the parent companies, and utilises the authority in practice to determine the safety and soundness of the bank;
• the supervisor has the authority to take remedial actions, including ring-fencing, regarding parent companies and non-bank affiliates concerning matters that could impact the safety and soundness of the bank, and
• the supervisor has the authority to establish and enforce fit and proper standards for owners and senior management of parent companies.

Corporate ownership of banks is not allowed at present.

Principle 21: Banking supervisors must be satisfied that each bank maintains adequate records drawn up in accordance with consistent accounting policies and practices that enable the supervisor to obtain a true and fair view of the financial condition of the bank and the profitability of its business, and that the bank publishes on a regular basis financial statements that fairly reflect its condition.

(i) The supervisor has the authority to hold management responsible for ensuring that financial record keeping systems and the data they produce are reliable, and that supervisor-required reports are submitted on a timely and accurate basis.

RBI has the authority to hold management of a bank responsible for ensuring that financial record keeping system and the data they produce are reliable. Section 46 of the BR Act vests powers in RBI to impose penalties for submission of unreliable information. DSB returns are required to be signed by a whole time director or Chief Executive Officer of banks. In case of submission of incorrect or incomplete information, it is treated as non-submission of return and invites penalty under Section 46 of the BR Act.

(ii) The supervisor has the authority to hold management responsible for ensuring that the management report and financial statements issued annually to the public receive proper external verification and bear an external auditor’s opinion.

It is mandatory for all banks to get their annual accounts audited every year by external auditors who are appointed with the approval of RBI. The auditors are required to report specifically whether the financial statements exhibit a true and fair view of the affairs of the bank.

(iii) The supervisor ensures that information from bank records is verified periodically through on-site examinations and/or external audits

Adequacy and accuracy of records maintained by banks are verified during on-site inspection by RBI.

(iv) The supervisor ensures that there are open communication lines with the external auditors.

RBI does not at present interact with the external auditors of banks. Some of the senior members of the audit profession are represented on the Central Board of RBI and the BFS of RBI. This provides for interaction and communication with the auditing fraternity. Audit Committee of the BFS lays down and reviews policies concerning audit of banks and financial institutions. Besides, one more Chartered Accountant from the Central Board and president of ICAI attend these meetings as invitees. Regular consultation with audit profession also takes place through meetings of Bank Audit Committee, which decides on the accounting standards and audit coverage.

RBI may consider having more interactions with the external auditors of banks. This will provide a deeper understanding of operations of banks and help in discharging supervisory functions better. It will be a good supplement to the on-site inspections of RBI.

(v) The supervisor provides instructions that clearly establish the accounting standards to be used in preparing supervisory reports. Such standards are based on accounting principles and rules that command wide international acceptance and are aimed specifically at banking institutions.

RBI has issued guidelines on preparation of various supervisory reports. These reports are based largely on internationally accepted accounting principles.

(vi) The supervisor requires banks to utilise valuation rules that are consistent, realistic and prudent, taking account of current values where relevant, and that profits are net of appropriate provisions.

RBI has laid down stringent asset classification and provisioning norms. Banks are required to lay down norms for valuation of collateral and value of collateral is not reduced from non-performing loans. Banks are required to provide for standard loans at the rate of 0.25 per cent from March 31, 2000. Current investments are marked to market. Declared net profits are net of provisions necessary for non-performing assets, liabilities and off-balance sheet items.

(vii) Laws or regulations set, or the supervisor has the authority, in appropriate circumstances, to establish, the scope and standards to be achieved in external audits of individual banks, and to make public issuance of individual bank financial statements subject to its prior approval.

Scope of statutory audit is defined in Section 30 of the BR Act. As per Section 31 of the BR Act, banks incorporated in India are required to publish their balance sheet and profit and loss account together with the auditor’s report in a newspaper in circulation at the place where the bank has its principal office. Further, banks have been advised to publish their annual accounts in abridged form in additional newspapers, journals, etc. to give wider coverage to banks’ operations. There are at present no set regulations or laws, which can make public issuance of individual bank financial statements subject to RBI’s prior approval.

Existing regulatory and legal provisions in regard to preparation and publishing of financial statements of banks are considered adequate.

(viii) The supervisor has the ability to treat as confidential certain types of sensitive information.

Section 34 A of BR Act gives right to RBI to decide whether the information sought in any proceeding is of confidential nature considering the principles of sound banking. Further, RBI has powers to publish any information obtained under BR Act if it is in public interest and in such consolidated form as it may think fit (Section 28 of BR Act). Thus, RBI has implied powers to treat sensitive information confidential.

(ix) The supervisor requires banks to produce annual audited financial statements based on accounting principles and rules that command wide international acceptance and have audited in accordance with internationally accepted auditing practices and standards.

The formats for preparation of financial statements are prescribed under Section 29 of the B R Act. The financial statements are prepared based on accounting standards prescribed by the ICAI except those that have been specifically modified by RBI in consultation with the ICAI keeping in view the nature of banking industry.

(x) The supervisor has the right to revoke the appointment of a bank’s auditors.

Prior permission of RBI is necessary for removal of statutory auditors (Section 30(1A) of BR Act). Further, in case professional incompetence is noticed, banks are advised to report to the ICAI, which initiates appropriate action.

(xi) Where supervisors rely primarily on the work of external auditors (rather than on their own examination staff), banks are required to appoint auditors who are recognised by the supervisor as having the necessary professional skills and independence to perform the work.

The selection process for external auditors for statutory and branch audit of banks is administered by RBI which ensures that only those having the necessary competence and experience would be entrusted with bank audit tasks.

(i) The supervisor promotes periodic public disclosures of information that are timely, accurate, and sufficiently comprehensive to provide a basis for effective market discipline.

The extent of disclosure in annual accounts has increased over the years. The BFS is considering moving to a system of half-yearly audited results. Listed banks are required to publish unaudited results quarterly in abridged form as per listing agreements. Recently, to ensure disclosure on par with international standards, banks are mandated to disclose certain additional information as part of annual financial statements:

• Capital Adequacy Ratio;
• Tier I capital ratio;
• Tier II capital ratio;
• Percentage of shareholding of the Government of India in nationalised banks;
• Net NPL ratio;
• Amount of provision made towards NPLs and provisions for income-tax for the year;
• Amount of Subordinated debt raised as Tier II capital (by way of explanatory notes / remarks in the balance sheet as well as in Schedule 5 relating to other liabilities and provision);
• Gross value of investments, provision for depreciation on investments and net value of investments separately for within India and outside India;
• Interest income as percentage to working funds;
• Non-interest income as a percentage to working funds;
• Operating profit as a percentage to working funds;
• Return on assets;
• Business (deposits and advances) per employee;
• Profit per employee;
• Maturity pattern of certain assets and liabilities;
• Movement in NPLs;
• Foreign currency assets and liabilities; and
• Lending to sensitive sectors as defined from time to time.

(ii) The supervisor has guidelines covering the scope and conduct of audit programmes that ensure that audits cover such areas as the loan portfolio, loan loss reserves, non-performing assets, asset valuations, trading and other securities activities, derivatives, asset securitisations, and the adequacy of internal controls over financial reporting.

Besides giving an audit report, the statutory auditors are also required to complete a quality assurance questionnaire (one for the bank as a whole and one for each branch), which covers aspects such as internal control, balances with other banks, investments, advances, premises, other assets and other liabilities, reserves and provisions, compliance with statutory reserve requirements, treasury operations and adherence to income recognition, asset classification and provisioning norms.

(iii) Auditors have the legal duty to report to the supervisor matters of material significance, for example, failure to maintain the licensing criteria, or breaches of banking or other laws. The law protects auditors from breach of confidentiality when information is communicated in good faith.

Statutory auditors have the responsibility of highlighting matters of material significance in their report to the annual accounts as per Companies Act. However, under the existing laws, no legal responsibility devolves on the auditors to report directly to the supervisor matters of material significance observed by them in the audit of banks.

Such legal provisions will be helpful to RBI in its oversight of banks and will keep banks as well as their auditors more vigilant about the fairness and accuracy of banks’ financial statements and their actual state of affairs. It will also enable the supervisors to place greater reliance on the role of external auditors in the audit of banks.

(iv) Auditors also have the legal duty to report matters to the supervisor, in situations where they become aware of matters which, in the context of the available information, they believe is likely to be of material significance to the functions of the supervisor.

The auditors are required to report matters, which should be brought to the notice of shareholders (Section 30(3)(e) of BR Act).

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V. Formal Powers of Supervisors

Principle 22: Banking supervisors must have at their disposal adequate supervisory measures to bring about timely corrective action when banks fail to meet prudential requirements (such as minimum capital adequacy ratios), when there are regulatory violations, or where depositors are threatened in any other way. In extreme circumstances, this should include the ability to revoke the banking licence or recommend its revocation.

(i) The supervisor has the authority, backed by legal sanctions, to take an appropriate range of remedial actions against, and impose penalties upon, banks, depending on the severity of a situation. These remedial actions are used to address such problems as failure to meet prudential requirements and violations of regulations. They range from informal oral or written communication with bank management to actions that involve the revocation of the banking licence.

RBI is vested with powers to issue directions under the BR Act where necessary in the interest of banking policy, in public interest or where the affairs of the banking company are being conducted in a manner detrimental to the interest of the depositors. It has powers to initiate action against banks, which fail to fulfil prudential requirements. Such remedial actions are wide ranging and are taken depending upon the severity of the situation. They range from informal oral communication to restrictions on branch expansion, assets expansion and setting up of subsidiaries and can extend up to actions, which can lead to revocation of licence.

(ii) The range of possible actions available is broad, including, in addition to the others mentioned, restricting the current activities of the bank, withholding approval of new activities or acquisitions, restricting or suspending payments to shareholders or share repurchases, restricting asset transfers, barring individuals from banking, replacing or restricting the powers of managers, directors, or controlling owners, arranging a take-over by or merger with a healthier institution, and imposing conservatorship.

The BR Act also gives RBI wide powers to issue directions to banks on any aspect of their business (Section 35A), appoint nominees on their boards, cause change of management (Sections 36AA and 36AB), cancel their Licence (Section 22), take monetary and non-monetary penal measures (Sections 46 to 48), cause merger/ amalgamations, impose restrictions or even close a problem bank. RBI, however, does not have powers to impose conservatorship.

Imposition of conservatorship can enable a bank in difficulty to gain some time until it completes remedial measures. Conservatorship is a workable solution where a bank in difficulty has the intrinsic strength to get over the difficulties but needs extensive corrective action under a more reliable management. It would be, therefore, desirable to provide RBI specifically with powers to impose conservatorship.

(iii) The supervisor ensures that remedial actions are taken in a timely manner.

In any remedial action, timeliness is crucial. Timeliness of remedial actions is also being specified under the scheme of Prompt Corrective Actions (PCA).

It would also be desirable to extend the PCA concept further and define clear limits of forbearance it would show in any situation.

(iv) The supervisor applies penalties and sanctions not only to the bank, but, when and if necessary, also to management and/or the board of directors.

There are provisions for imposing monetary penalties against delinquent officials. In extreme cases, the top management of banks or the Directors on the board may be replaced. The sanctions applied by the supervisor depends upon its assessment of the severity of the situation. In deciding the course of its action, the supervisor takes into account the consequences of the default and violations observed in the functioning of banks and the impact its own actions will have on the individual bank, shareholders and the entire system. However, the public sector character of banks remains a limitation in the supervisor deciding upon and initiating remedial action in respect of banks.

RBI should consider introduction of measures by which clear accountability can be fixed on individual directors and/or the board of directors for non-performance and/or negligence of their duties. Accountability, if fixed, should lead to penalties and, in extreme cases, if necessary, criminal prosecution.

(i) Laws and/or regulations mitigate against the supervisor unduly delaying appropriate corrective actions.

As of now, laws/ regulations do not have clear provisions which mitigate against undue delay on the part of supervisors. However, Prompt Corrective Actions are now being defined and triggers for specific remedial actions are being set. With a well-defined regime of Prompt Corrective Action in place, undue delays on the part of the supervisor in taking appropriate corrective action will be substantially mitigated.

The PCA regime should be kept under constant review so that it can be refined and made increasingly fail-safe. Identification of new triggers should be a regular process and actions that will follow will have to be specified.

(ii) The supervisor addresses all significant remedial actions in a written document to the board of directors and requires that progress reports are submitted in writing as well.

Negative features and action called for as detected in on-site and off-site monitoring are addressed in a written communication to the chairmen of banks. Implementation of remedial actions is monitored periodically. Periodicity of such monitoring depends on seriousness of the problems faced by banks. Banks’ balance sheets are analysed and supervisory concerns emanating therefrom are communicated to the Chief Executive Officers. Banks are also advised to place the communication before their boards and suggest action.

Principle 23: Banking supervisors must practise global consolidated supervision over their internationally active banking organisations, adequately monitoring and applying appropriate prudential norms to all aspects of the business conducted by these banking organisations worldwide, primarily at their foreign branches, joint ventures and subsidiaries.

(i) The supervisor has the authority to supervise the overseas activities of locally incorporated banks.

The BR Act gives powers to RBI to inspect overseas activities of banks incorporated in India.

(ii) The supervisor satisfies itself that management is maintaining proper oversight of the bank’s foreign branches, joint ventures, and subsidiaries. It also satisfies itself that the local management of any overseas offices has the necessary expertise to manage those operations in a safe and sound manner.

RBI has prescribed periodic review of working of overseas branches to be put up to the board. RBI undertakes annual appraisal of banks’ overseas activities based on records maintained at Head Office to ensure that prudential regulations are complied with and management has necessary expertise to manage these operations in a safe and sound manner.

While the position in regard to foreign branches of Indian banks is generally satisfactory, in the context of consolidated supervision, the position in regard to subsidiaries and particularly of joint ventures is not the same as that of branches. As we intend moving towards consolidated supervision, these areas will have to be addressed specifically.

(iii) The supervisor determines that bank management’s oversight includes:
a) information reporting on its overseas operations that is adequate in scope and frequency and is periodically verified;
b) assessing in an appropriate manner compliance with internal controls; and
c) ensuring effective local oversight of foreign operations.

These are assessed during on-site inspection of head office and overseas branches of banks and through off-site reporting system specifically designed to cover overseas branches of Indian banks. The branches are also covered by independent internal audit function either by an in-house group or external professional accountant firm appointed in consultation with the host country regulator, where such approvals are necessary.

(iv) The home country supervisor has the authority to require closing of overseas offices, or imposing limitations on their activities, if it determines that the supervision of a local operation by the bank and/or by the host country supervisor is not adequate relative to the risks the office presents.

RBI has the required authority for closing of overseas offices of Indian banks or imposing limitations on their activities.

(i) The supervisor has a policy for assessing whether it needs to conduct on-site examinations or require additional reporting, and it has the legal authority and resources to take those steps as and when appropriate.

Sections 35 and 27 of BR Act give powers to RBI to conduct inspection of overseas branches of Indian banks and to call for any information from them. Overseas branches of locally incorporated banks are inspected depending on the feedback received during on-site inspection of the head office of banks and off-site monitoring. Additional information is called for whenever considered necessary.

(ii) The supervisor determines that management’s local oversight of foreign operations is particularly close when the foreign activities differ fundamentally from those conducted in the home country, or are conducted at locations that are especially remote from the principal locations at which the bank conducts comparable activities.

The extent and nature of oversight by the local management over the activities of individual operating units is left largely to the management.

RBI should move in this direction and look at the extent of oversight exercised by the local management over its specific units. While the business of the foreign unit has a special character, as supervisor, RBI should ensure that the oversight exercised by the management matches the requirement of the situation.

(iii) The supervisor arranges to visit the offshore locations periodically, the frequency determined by the size and risk profile of the overseas operation. The supervisor meets the local supervisors during these visits.

There are need based visits to overseas branches by RBI supervisors particularly to those clusters of branches functioning in important global money market centres. At the end of such visits, an exchange of information on important findings of the visit and concerns relating to the Indian branches of banks headquartered in the host country also takes place with the host country regulator.

The present approach, which is selective and therefore has some elements of ad-hocism, should be replaced by a system under which all foreign operations of Indian banks receive on-site supervisory oversight in a planned manner.

(iv) The home country supervisor assesses the quality of supervision conducted in the countries in which its banks have material operations.

Quality of supervision is one of the major factors considered before granting licence for opening a branch overseas.

The assessment of the host country’s supervision should be more rigorous. It would be desirable to introduce a structured assessment and not permit banks to open offices in areas where the quality of supervision does not measure up to international standards.

Principle 24: A key component of consolidated supervision is establishing contact and information exchange with the various other supervisors involved, primarily host country supervisory authorities.

(i) For significant overseas operations of its banks, the home country supervisor establishes informal or formal arrangements (such as memoranda of understanding) with host country supervision for appropriate information sharing on the financial condition and performance of such operations in the host country. Information sharing arrangements with host country supervisors include being advised of adverse assessments of such qualitative aspects of a bank’s operations as the quality of risk management and controls at the offices in the host country.

RBI maintains contact/relations with overseas supervisors. However, such relations have not been put on a formal footing. In some cases there are also issues relating to reciprocity. Working Group on Home and Host country supervisory relationship recommended putting in place formal and/or informal arrangements for sharing information with overseas regulators. High level teams from RBI periodically visit overseas supervisors and share information.

Formal arrangements between home and host country supervisors for sharing of information and concerns would be preferable to having only informal arrangements. RBI should endeavour to get into formal relationship with host country supervisors on the basis of MOUs. It is only when there is good understanding between home and host country supervisors that the overall quality of supervision can come up to the desired level.

(ii) The supervisor can prohibit banks or their affiliates from establishing operations in countries with secrecy laws or other regulations prohibiting flows of information deemed necessary for adequate supervision.

RBI has the powers to prohibit banks or their affiliates from establishing operations in countries where its supervisory reach will be limited in any manner.

(iii) The home supervisor provides information to host country supervisors concerning the specific offices in the host country, concerning the overall framework of supervision in which the banking group operates, and, to the extent appropriate, concerning significant problems arising in the head office or in the group as a whole.

RBI shares information with foreign supervisors on reciprocal basis.

The system of entering into formal relationship with host country supervisors on the basis of MOU suggested above (against item (i) above) will provide the necessary framework for exchange of this kind of information.

(i) A supervisor who takes consequential action on the basis of information received from another supervisor, consults with that supervisor, to the extent possible, beforehand.

This is done to the extent possible.

(ii) Even for less than significant overseas operations of its banks, the home country supervisor exchanges appropriate information with host country supervisors.

Such information is shared on need based basis.

Principle 25: Banking supervisors must require the local operations of foreign banks to be conducted to the same high standards as are required of domestic institutions and must have powers to share information needed by the home country supervisors of those banks for the purpose of carrying out consolidated supervision.

(i) Local branches and subsidiaries of foreign banks are subject to similar prudential, inspection, and regulatory reporting requirements as domestic banks.

The position obtains.

(ii) For purposes of the licensing process as well as ongoing supervision, the host country supervisor assesses whether the home country supervisor practises consolidated global supervision.

While permitting opening of branches by foreign banks, RBI checks whether home country supervisor takes a consolidated view of the group operations. But no proposal is rejected merely on the grounds of non-existence of consolidated supervision at the home country level.

(iii) The host supervisor, before issuing a licence, determines that approval (or no objection) from the home supervisor has been received.

No objection certificate from home country is required for permitting opening of a branch in India.

(iv) The host country supervisor can share with home country supervisors information about the local operations of foreign banks provided its confidentiality is protected.

There is no formal framework for ‘Home country and Host country Supervisory Relationship’. However, RBI shares information with home country supervisors of foreign banks depending on need. Confidentiality is maintained by practice.

(v) Home country supervisors are given on-site access to local offices and subsidiaries for safety and soundness purposes.

Home country supervisors have to obtain prior permission for on-site access to branches of foreign banks operating in India, which is normally granted.

(vi) The host country supervisor advises home country supervisors on a timely basis of any material remedial action it takes regarding the operations of a bank from that country.

Annual Financial Inspection reports of foreign banks are forwarded to their local head offices with an advice to put up the report before their Local Advisory Board and also to obtain comments of their parent bank. As of now there is no formal or set arrangement for RBI to share information with the home country regulator directly about any material remedial action it takes regarding the operations of a bank from that country. There is also no clear view as to what would constitute ‘material remedial action’. The view so far has been one of reciprocity and subject to that RBI has shared such information with home country supervisors.

The host country supervisor obtains from home country supervisors sufficient information on the banking group to allow it to put into proper perspective the activities conducted within its borders.

RBI has in the past focused more on individual operations than on the consolidated position.