eStandardsForum - Financial Standards Foundation

Browse Profiles > India > Core Principles for Effective Banking Supervision

	Score	Rank
Standards Compliance Index	38.33 out of 100	47
Business Indicator Index	5.48 out of 12	71

India

Core Principles for Effective Banking Supervision

Summary

Enacted

General Overview

A 2004 report by the RBI on progress made since 2001 assessment by the advisory group indicate that substantial progress has been made in implementing standards relating to banking supervision since the recommendations of the Advisory Group were put forth. India has been complying with standards set by the Basel Committee in almost all its aspects. It has actively participated in evolving these standards with formal comments on the Consultative Papers of the Bank for International Settlement (BIS) and by participation in the quantitative impact studies (QIS). Furthermore, risk-based supervision on was adopted. However the RBI report stresses the need to continue this momentum and strengthen supervision aspects of other related areas, especially in financial conglomerates and cross-border banking. (RBI 2004, p. 53)

As per a 2006 IMF report, there is a favorable perception overseas that India is conforming to best international standards. According to Standard & Poor's, Indian banks' ratio of gross nonperforming assets - including non-performing loans (NPLs), parts of restructured assets, and foreclosed properties - stood at 8-10 percent as of March 2005. In terms of capital adequacy, with relatively better interest margins, low provisioning needs, and stronger net profitability, Indian banks have been able to build a stronger capital base. India is set to implement Basel II effective March 31, 2007. India will initially adopt the standardized approach for credit risk and the basic indicator approach for operational risk. After adequate skills are developed, both by the banks and also by the supervisor (RBI), some banks may be allowed to migrate to the internal ratings-based approach (IRB). (IMF 2006, pp. 87-90)

The RBI is the central banking institution. It is the sole authority for issuing bank notes and the supervisory body for banking operations in India. It supervises and administers exchange control and banking regulations, and administers the government's monetary policy. It is also responsible for granting licenses for new bank branches. The Deposit Insurance and Credit Guarantee Corporation, an organization promoted and fully funded by the RBI, offers deposit insurance facilities. The RBI directs banks to meet the Bureau of Indian Standards guidelines. Indian banks must also adhere to the prudential norms laid down by the Basel Group. (U.S. DoC 2006, p. 123)

The 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. The laws supporting regulation and the guidelines and prudential norms issued by the RBI from time to time provide a framework of minimum prudential standards that banks must meet. (RBI 2001, pp. 95-96)

An independent Board for Financial Supervision (BFS) under the aegis of the Reserve Bank has been established as the apex supervisory authority for commercial banks, financial institutions, urban banks and non-banking financial companies (NBFCs). Consistent with international practice, BFS's focus is on offsite and on-site inspections and on banks' internal control systems. Offsite surveillance has been strengthened through control returns. The role of statutory auditors has been emphasized with increased internal control through strengthening of the internal audit function. Significant progress has been made in implementation of the Core Principles for Effective Banking Supervision. The supervisory rating system under CAMELS (Capital adequacy, Asset quality, Management, Earnings, Liquidity and Systems and Controls) has been established, coupled with a move towards risk-based supervision. Consolidated supervision of financial conglomerates has since been introduced with bi-annual discussions with the financial conglomerates. There have also been initiatives aimed at strengthening corporate governance through enhanced due diligence on important shareholders, and fit and proper tests for directors. A scheme of Prompt Corrective Action (PCA) is in place for attending to banks showing steady deterioration in financial health. Three financial indicators, viz. capital to risk-weighted assets ratio (CRAR), net non-performing assets (net NPA) and Return on Assets (RoA) have been identified with specific threshold limits. When the indicators fall below the threshold level (CRAR, RoA) or go above it (net NPAs), the PCA scheme envisages certain structured/discretionary actions to be taken by the regulator. (BIS 2006, p. 240)

According to a 2006 report by the Institute of International Bankers, the RBI has strengthened the regulatory and supervisory framework to align it with international best practices with suitable adaptations. Regulation and supervision has been guided by the objective of maintaining confidence in the financial system by enhancing its soundness and efficiency. With a view to enhance the transparency and to strengthen corporate governance practices, a detailed framework was already established by the RBI for diversified ownership. The RBI also continued to monitor the progress of the banking sector for the implementation of the Basel II accord. Further, it also stressed the need for financial inclusion by emphasizing the facilitation of transactions by the common person and strengthening of the credit delivery systems, as a response to the pressing societal needs of the economy. (IIB 2006, p. 109)

According to a 2006 Bank for International Settlements (BIS) report, prudential norms related to risk-weighted capital adequacy requirements, accounting, income recognition, provisioning and exposure were introduced in 1992 and gradually these norms have been brought up to international standards. Other initiatives in the area of strengthening prudential norms include measures to strengthen risk management through recognition of different components of risk, assignment of risk-weights to various asset classes, norms on connected lending and risk concentration, application of the mark-to-market principle for investment portfolios and limits on deployment of funds in sensitive activities. (BIS 2006, p. 238)

India has an extensive banking network, in both urban and rural areas. The banking system has three tiers. These are: the scheduled commercial banks; the regional rural banks, which operate in rural areas, not covered by the scheduled banks; and the cooperative and special purpose rural banks. There are approximately 80 scheduled commercial banks, Indian and foreign; almost 200 regional rural banks; more than 350 central cooperative banks, 20 land development banks; and a number of primary agricultural credit societies. Large Indian banks, and most Indian financial institutions are in the public sector. Though public sector banks (27 of them) currently dominate the banking industry, numerous private and foreign banks exist. Several public sector banks are being restructured, and in some cases the government either has already reduced, or is in the process of reducing its ownership. In terms of business, the state-owned banks account for more than 70 percent of deposits and loans. Private banks handle 17 percent of the market, and foreign banks located in metropolitan area account for approximately 13 percent of the market. There are more than 40 foreign banks operating in India with more than 200 branches, most of which are located in metropolitan centers. The entry of foreign banks is based on reciprocity, economic and political bilateral relations. Foreign banks in India are subject to the same regulations as scheduled banks. (U.S. DoC 2006, pp. 122-123)

"Code of Banks' Commitment to customers" was released by the RBI on 1st July, 2006. This Code signifies the first collaborative effort by the RBI, the banks and the newly set up Banking Codes and Standards Board of India (BCSBI) to provide a framework for a minimum standard of banking services, which individual customers can legitimately expect. The code brings greater focus on customers and has incorporated some of the regulatory guidelines and practices followed elsewhere. (IIB 2006, p. 111)

The Principles

1. (1) Clear responsibilities and objectives for each supervisory agency.

1.(2) Operational independence and adequate resources.

1.(3) A suitable legal framework for authorization and ongoing supervision.

1.(4) A suitable legal framework to address compliance with laws as well as safety and soundness concerns.

1.(5) Legal protection for supervisors.

1.(6) Arrangement for sharing of information between supervisors and protection of confidentiality of shared information.

2. Clearly defined permissible activities for banks and control of the use of the word 'bank'.

3. Criteria for structure, directors, operating plan, controls, financial condition and capital base.

The Advisory Group on Banking Supervision (the Group) of the Reserve Bank of India (RBI) released in 2001 a detailed assessment in regard to qualitative levels of compliance with the Core Principles (CPs) in India using the methodology suggested by Basel Committee on Banking Supervision (BCBS). The assessments made by the Group indicate a high level of general compliance in regard to most of the principles when evaluated against the recommended essential and additional criteria. (RBI 2001, p. 5) However, subsequent to the 2001 assessment by the RBI, there is no publicly available assessment as to India's compliance with the Core Principles for Effective Banking Supervision.

The RBI follows very strict licensing norms and these are reviewed periodically. It also has the powers to reject an application. While licensing banks, the RBI makes a detailed assessment of the character of the proposed management and determines the suitability of the major shareholders, transparency of ownership structure and source of initial capital. Minimum capital is also prescribed. Fit and proper test is applied to evaluate the directors and the top management. The proposed strategic and operating plans of the banks and their viability are also reviewed. In the case of foreign banks, the prior consent of the home country supervisor is obtained. The compliance with the conditions imposed at the time of licensing is monitored through a quarterly system of on-site supervision. (RBI 2001, p. 12)

The criteria for licensing are set out in Section 22(3) of the BR Act. The RBI has also set prudential norms including norms for capital adequacy, which are followed, in licensing banks. The criteria for issuing licenses laid down in the Banking Regulation (BR) Act are consistent with major objectives of ongoing supervision. The RBI has powers to reject an application for granting of license if requisite criteria are not fulfilled or if the information provided is not adequate. As per Section 22 (3c) of the BR Act, the general character of the proposed management is evaluated to ensure that it will not be prejudicial to the interests of present or future depositors. (RBI 2001, p. 103)

Section 22(3) (d) of the BR Act provides for ensuring adequacy of capital structure before the granting of license. 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. Based on the information provided in a 2004 RBI report, the issue of revision of minimum capital requirement and the supervisory process was under review. The RBI could consider its legal, institutional and regulatory aspects in the context of discriminatory capital charge for proper risk management. (RBI 2001, p. 103; RBI 2004, p. 44)

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 the head office of banks over their branches and other offices is evaluated and rated as part of CAMELS (Capital adequacy, Asset quality, Management, Earnings, Liquidity and Systems and Controls) rating done during on-site inspections. (RBI 2001, pp. 103-104)

The operational structures of banks are examined as part of the licensing process. Projected financial statements are obtained for three years to study viability of the proposed strategic plan. Financial strength of promoters is evaluated. The RBI is both the licensing as well as the supervising authority and the RBI insists on prior consent of the home country regulator with regards to foreign banks. Furthermore, the RBI can cancel the license 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, the RBI can revoke the license of a banking company that is obtained based on false information. (RBI 2001, pp. 103-104)

4. Authority to review and reject transfer of ownership.

5. Authority to review major acquisitions and investments.

6. Minimum capital adequacy requirements (meet Basle Capital Accord for internationally active banks).

7. A method exists for the evaluation of procedures related to loans, investments and portfolio management.

8. Policies, practices and procedures for evaluating the quality of assets and the adequacy of loan loss provisions and reserves.

The Advisory Group on Banking Supervision (the Group) of the Reserve Bank of India (RBI) released in 2001 a detailed assessment in regard to qualitative levels of compliance with the Core Principles (CPs) in India using the methodology suggested by Basel Committee on Banking Supervision (BCBS). The assessments made by the Group indicate a high level of general compliance in regard to most of the principles when evaluated against the recommended essential and additional criteria. (RBI 2001, p. 5) However, subsequent to the 2001 assessment by the RBI, there is no publicly available assessment as to India's compliance with the Core Principles for Effective Banking Supervision.

The 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. 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. The system of classification and provisioning include only such off-balance sheet items that are likely to get converted into on-balance sheet items. 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. (RBI 2001, pp. 114-115)

Loan recovery policies of banks are studied during on-site inspections to assess adequacy of procedures and organizational set-up to recover past due loans. RBI has powers to give banks specific directions for ensuring adequacy of provisions under section 35A of the Banking Regulation (BR) Act. RBI impresses upon banks to reduce exposure to certain sectors, if found excessive, and improve quality of credit appraisal, if found lacking. 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 there against and interest in arrears are called for and analyzed. There are general instructions for periodic evaluation of the worth of collaterals including guarantees. However, practices followed in this regard are not uniform. Loans are being classified as impaired even if the default in payment of principal/interest is less than two quarters. (RBI 2001, p. 116)

According to a 2006 Bank for International Settlements (BIS) report, prudential norms related to provisioning and exposure were introduced in 1992 and gradually these norms have been brought up to international standards. Other initiatives in the area of strengthening prudential norms include measures to strengthen risk management through recognition of different components of risk, assignment of risk-weights to various asset classes, norms on connected lending and risk concentration, application of the mark-to-market principle for investment portfolios and limits on deployment of funds in sensitive activities. (BIS 2006, p. 238)

The asset classification norms whereby assets are classified into four categories, viz., standard assets, sub-standard assets, doubtful assets and loss assets, were prescribed with appropriate provisioning requirements for each category of assets. The concept of "past due" in the identification of non-performing assets (NPAs) was dispensed in March 2001, and the 90-day delinquency norm as adopted for the classification of NPAs effective from March, 2004. Effective from the year-end March-2005, an asset would be classified as doubtful if it remained in the sub-standard category for 12 months as against the earlier norm of 18 months. Graded Higher Provisioning was introduced in March, 2005 in respect of: (1) secured portion of NPAs included in "doubtful" for more than three years category; and (2) NPAs which have remained in doubtful category for more than three years as on March 31, 2004. (IIB 2006, pp. 109-110)

There has been a marked improvement in asset quality with the percentage of gross NPAs to gross advances for the banking system declining from 14.4 per cent in 1998 to 5.2 per cent in 2005. Globally, the non-performing loan (NPL) ratio varies widely from a low of 0.3 per cent to 3.0 per cent in developed economies, to over 10.0 per cent in several Latin American economies. The reform measures have also resulted in an improvement in the profitability of banks. (BIS 2006, p. 241)

9. Prudential limits and management information system on concentration of exposure.

10. Arm's length rule and monitoring for connected lending.

11. Policies and procedures for country risk and transfer risk.

12. Measuring and monitoring market risk. Limit and/or specific capital charge on market risk exposure.

13. Comprehensive risk management processes.

The Advisory Group on Banking Supervision (the Group) of the Reserve Bank of India (RBI) released in 2001 a detailed assessment in regard to qualitative levels of compliance with the Core Principles (CPs) in India using the methodology suggested by Basel Committee on Banking Supervision (BCBS). The assessments made by the Group indicate a high level of general compliance in regard to most of the principles when evaluated against the recommended essential and additional criteria. (RBI 2001, p. 5) However, subsequent to the 2001 assessment by the RBI, there is no publicly available assessment as to India's compliance with the Core Principles for Effective Banking Supervision.

The RBI has issued detailed guidelines for risk management and is monitoring their implementation regularly. Inspections are conducted using in-house expertise, whose skills are being constantly upgraded, and occasionally also through chartered accountants for specific targeted appraisals. (RBI 2001, p. 13)

The 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. (RBI 2001, p. 126)

The 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. The RBI has issued guidelines on management of liquidity based on residual maturity of assets, undrawn 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. Primary responsibility of adhering to laid down prudential limits and procedures rests with the relevant business units. The 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 the RBI. Besides off-site monitoring procedures, the annual on-site inspections ensure adherence to the set guidelines by banks. (RBI 2001, p. 128)

The 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 management information systems (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 percent of total foreign exchange turnover. (RBI 2001, pp. 126-127)

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. The 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 the 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. (RBI 2001, pp. 127-128)

According to a 2006 Bank for International Settlements (BIS) report, prudential norms related to risk-weighted capital adequacy requirements, accounting, income recognition, provisioning and exposure were introduced in 1992 and gradually these norms have been brought up to international standards. Other initiatives in the area of strengthening prudential norms include measures to strengthen risk management through recognition of different components of risk, assignment of risk-weights to various asset classes, norms on connected lending and risk concentration, application of the mark-to-market principle for investment portfolios and limits on deployment of funds in sensitive activities. (BIS 2006, p. 238)

14. Adequate internal controls.

The Advisory Group on Banking Supervision (the Group) of the Reserve Bank of India (RBI) released in 2001 a detailed assessment in regard to qualitative levels of compliance with the Core Principles (CPs) in India using the methodology suggested by Basel Committee on Banking Supervision (BCBS). The assessments made by the Group indicate a high level of general compliance in regard to most of the principles when evaluated against the recommended essential and additional criteria. (RBI 2001, p. 5) However, subsequent to the 2001 assessment by the RBI, there is no publicly available assessment as to India's compliance with the Core Principles for Effective Banking Supervision.

The RBI determines that banks have in place internal controls that are adequate for the nature and scale of their business. It has means of collecting, reviewing and analyzing prudential reports and statistical returns from banks. As per Section 292-A of the Companies Act it would be mandatory for every public company having paid up capital of not less than Rs. 500,000,000 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 organization-wide level with internal control systems. (RBI 2001, pp. 13, 130)

The RBI has laid clear stress on the setting up of risk management systems and in its guidelines given to banks in this regard, spells 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) the Board should review the progress in implementation of the guidelines at half yearly intervals; and (2) constitute an independent Risk Management Committee or Executive Committee for evaluating overall risk assumed by the bank. The 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. The 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 foreign exchange transactions conformity to which is verified during on-site inspections by RBI. (RBI 2001, pp. 131-132)

The supervisor (RBI) 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. 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/organization. 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. (RBI 2001, pp. 132-133)

Each bank has an internal audit department that inspects the bank's functioning periodically and reports to the Audit Committee. All exceptionally large branches and large branches are subjected to concurrent audit so as to cover at least 50 percent 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 the 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. Extant RBI guidelines to its supervisors require them to have a comprehensive evaluation of audit function with reference to such reports. (RBI 2001, pp. 133-134)

15. Strict "know-your-customer" rules and high ethical and professional standards.

The Advisory Group on Banking Supervision (the Group) of the Reserve Bank of India (RBI) released in 2001 a detailed assessment in regard to qualitative levels of compliance with the Core Principles (CPs) in India using the methodology suggested by Basel Committee on Banking Supervision (BCBS). The assessments made by the Group indicate a high level of general compliance in regard to most of the principles when evaluated against the recommended essential and additional criteria. (RBI 2001, p. 5) However, subsequent to the 2001 assessment by the RBI, there is no publicly available assessment as to India's compliance with the Core Principles for Effective Banking Supervision. In November 2004, the RBI revised the guidelines on "Know Your Customer" (KYC) principles in line with the recommendations made by the Financial Action Task Force (FATF) on Anti-Money Laundering Standards and combating financing of terrorism. Banks have to put in place a board-approved KYC policy for implementation in their respective banks. The salient features of the policy relate to the procedure prescribed with regard to customer acceptance, customer identification, risk management, monitoring as required under Prevention of Money Laundering Act (PMLA), 2002. To have a uniform standard, as requested by the RBI, Indian Banks' Association came out with the Anti-Money Laundering and KYC policy document for adoption by banks in 2005. In order to ensure that the inability of the persons belonging to low income groups to produce documents to establish their identity and address does not lead to their financial exclusion and denial of banking services further, simplified procedure has been provided for opening accounts for those persons who do not intend to keep balances above Rs. 50,000 and whose total credit in one year is not expected to exceed Rs. 100,000. (IIB 2006, p. 110)

The PMLA 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. 2,500,000 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 for five years from the date of cessation of transaction between the client and the financial institution. (RBI 2001, pp. 135-136)

Banks have also been advised to be careful while dealing with clients who deposit and withdraw large sums of money in cash. Transactions of Rs. 1,000,000 and above are required to be closely monitored by banks. All banks have dual authorization 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. (RBI 2001, p. 136)

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 the RBI under the reporting system prescribed by the RBI. This vigilance function in banks coordinates with the RBI as well as the Central Vigilance Commission (for government owned banks). The RBI has advised banks to report frauds immediately to the concerned investigative agency particularly in respect of large value frauds. (RBI 2001, pp. 135-136)

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 PMLA also has a provision requiring banks to report suspicious activities to the Financial Intelligence Unit of India. 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. (RBI 2001, p. 137)

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. The RBI has the general powers to proceed against banks for violations of its regulations. The modus operandi of frauds reported to the 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. 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. (RBI 2001, p. 138)

16. Effective supervisory system consisting of on-site and off-site supervision.

17. Regular contact with bank management and understanding of bank's operations.

18. Analytical reports and statistical returns on solo and consolidated basis.

The Advisory Group on Banking Supervision (the Group) of the Reserve Bank of India (RBI) released in 2001 a detailed assessment in regard to qualitative levels of compliance with the Core Principles (CPs) in India using the methodology suggested by Basel Committee on Banking Supervision (BCBS). The assessments made by the Group indicate a high level of general compliance in regard to most of the principles when evaluated against the recommended essential and additional criteria. (RBI 2001, p. 5) However, subsequent to the 2001 assessment by the RBI, there is no publicly available assessment as to India's compliance with the Core Principles for Effective Banking Supervision.

Under Section 27 of the Banking Regulation (BR) Act, the 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. At the time of 2001 assessment, the RBI received prudential reports and statistical returns from banks on a solo basis only. Subsequently, however, all banks under the purview of consolidated supervision of the RBI, whether listed or unlisted, are required to prepare and disclose consolidated financial statements (CFSs) from the financial year commencing from April 1, 2002 in addition to their financial statements. The CFSs are required to be prepared in accordance with the Accounting Standards 21, 23 and 27 prescribed by the Institute of Chartered Accountants of India (ICAI). Banks are coming under the purview of consolidated supervision would also need to prepare Consolidated Prudential Reports (CPRs) in addition to CFSs. CPRs were initially introduced on a half-yearly basis from March 31, 2003 as part of the off-site reporting system. The CPR should contain information and accounts of related entities which carry on activities of banking and financial nature and should not include group companies engaged in insurance or non-financial activities. Prudential norms/limits similar to those as applicable to banks are prescribed for compliance by the consolidated bank. (RBI 2001, p. 143; RBI 2003, p. 168)

The RBI receives quarterly/half-yearly/yearly statutory returns on various aspects like assets and liabilities, profitability, capital adequacy, large exposures, asset quality, connected lending, 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 has been in place from the quarter ending June 1999. Board for Financial Supervision (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. (RBI 2001, p. 143)

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 the RBI can invite imposition of penalties specified in Section 46(1) of the BR Act. (RBI 2001, p. 144)

The balance sheet format and prudential and statistical reports are standardized. 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 lending, ownership and control, maturity profile of foreign exchange positions, interest rate sensitivity for overseas and domestic operations and structural liquidity. (RBI 2001, p. 144)

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. The RBI is in a position to call for any information about related companies of banks through the concerned bank. 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. (RBI 2001, p. 145)

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. The 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, the RBI can call for ad-hoc returns from specific banks for specified purposes. (RBI 2001, p. 145)

19. Independent validation of supervisory information through on-site examination or external auditors.

20. Ability to supervise on a consolidated basis.

21. Consistent accounting policies and practices that provide a true and fair view of the financial condition of the bank.

The Advisory Group on Banking Supervision (the Group) of the Reserve Bank of India (RBI) released in 2001 a detailed assessment in regard to qualitative levels of compliance with the Core Principles (CPs) in India using the methodology suggested by Basel Committee on Banking Supervision (BCBS). The assessments made by the Group indicate a high level of general compliance in regard to most of the principles when evaluated against the recommended essential and additional criteria. (RBI 2001, p. 5) However, subsequent to the 2001 assessment by the RBI, there is no publicly available assessment as to India's compliance with the Core Principles for Effective Banking Supervision.

The RBI has systems in place and makes ongoing efforts to ensure that banks maintain adequate records based on consistent accounting policies and that the financial statements prepared and published based on such records represent a true and fair state of the banks. These are also independently validated by external auditors and by the RBI during on-site inspections. Local operations of foreign banks are also required to be conducted to the same high standards as are required of domestic institutions. (RBI 2001, p. 13)

Indian banking financial statements conforms to internationally recognized standards, but, in some cases, are modified to suit Indian conditions. The RBI issues circulars to all banks in this regard and advises banks to follow these guidelines. Banks are free to choose their auditors. Most foreign banks and the more progressive private Indian banks work with international auditing firms. Many private and Government of India (GOI) banks continue to work with local auditing firms. (U.S. DoC 2006, p. 123)

The 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 Banking Regulation (BR) Act vests powers in RBI to impose penalties for submission of unreliable information. 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. It is mandatory for all banks to get their annual accounts audited every year by external auditors who are appointed with the approval of the RBI. The auditors are required to report specifically whether the financial statements exhibit a true and fair view of the affairs of the bank. Adequacy and accuracy of records maintained by banks are verified during on-site inspection by the RBI. (RBI 2001, p. 152)

The 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 Board for Financial Supervision (BFS) of the RBI. This provides for interaction and communication with the auditing fraternity. The 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 Institute of Chartered Accountants of India (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. The RBI has issued guidelines on preparation of various supervisory reports. These reports are based largely on internationally accepted accounting principles. (RBI 2001, p. 153)

The 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. The 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. (RBI 2001, pp. 153-154)

Section 34 A of BR Act gives right to the RBI to decide whether the information sought in any proceeding is of confidential nature considering the principles of sound banking. Further, the 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, the RBI has implied powers to treat sensitive information confidential. The formats for preparation of financial statements are prescribed under Section 29 of the BR 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. (RBI 2001, pp. 154-155)

Prior permission of the 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. The selection process for external auditors for statutory and branch audit of banks is administered by the RBI which ensures that only those having the necessary competence and experience would be entrusted with bank audit tasks. (RBI 2001, p. 155)

Indian banks are already disclosing quite a lot of information pertaining to capital adequacy with regard to non-performing assets (NPAs), the maturity profile of their assets and liabilities, various performance ratios, country exposure, issuer composition of non-SLR investments etc. It was also decided to disclose penalties received by the bank from the regulators. With a view to ensuring that banks make meaningful disclosures of their derivative portfolios, a minimum framework for disclosures by banks on their risk exposures in derivatives was advised to the commercial banks. The guidelines included both qualitative and quantitative aspects to provide a clear picture of the exposure to risks. (IIB 2006, p. 110)

22. Adequate supervisory measures to ensure timely corrective action.

23. Banking supervisors must practice global consolidated supervision over their internationally-active banking organizations.

24. International exchange of information with other supervisors.