The Banking Regulation Act, 1949 empowers the Reserve Bank of India to inspect and supervise commercial banks. These powers are exercised through on-site inspection and off site surveillance.

Till 1993, regulatory as well as supervisory functions over commercial banks were performed by the Department of Banking Operations and Development (DBOD). Subsequently, a new Department of Banking Supervision (DBS) was set up to take over the supervisory functions relating to the commercial banks from DBOD. For dedicated and integrated supervision over all credit institutions, i.e., banks, development financial institutions and non-banking financial companies, the Board for Financial Supervision (BFS) was set up in November 1994 under the aegis of the Reserve Bank of India. For focussed attention in the area of supervision over non-banking finance companies, Department of Supervision was further bifurcated in August 1997 into Department of Banking Supervision (DBS) and Department of Non-Banking Supervision (DNBS). These Departments now look after supervision over commercial banks & development financial institutions and non-banking financial companies, respectively. Both these departments now function under the direction of the Board for Financial Supervision (BFS).

The Board for Financial Supervision constituted an audit sub-committee in January 1995 with the Vice-Chairman of the Board as its Chairman and two non-official members of BFS as members. The sub-committee’s main focus is upgradation of the quality of the statutory audit and concurrent / internal audit functions in banks and development financial institutions.

On site Inspection

On site inspection of banks is carried out on an annual basis. Besides the head office and controlling offices, certain specified branches are covered under inspection so as to ensure a minimum coverage of advances.

The Annual Financial Inspection (AFI) focusses on statutorily mandated areas of solvency, liquidity and operational health of the bank. It is based on internationally adopted CAMEL model modified as CAMELS, i.e., capital adequacy, asset quality, management, earning, liquidity and system and control. While the compliance to the inspection findings is followed up in the usual course, the top management of the Reserve Bank addresses supervisory letters to the top management of the banks highlighting the major areas of supervisory concern that need immediate rectification, holds supervisory discussions and draws up an action plan, that can be monitored. All these are followed up vigorously. Indian commercial banks are rated as per supervisory rating model approved by the BFS which is based on ‘ CAMELS ‘ concept.

Off-site Monitoring

As part of the new supervisory strategy, a focussed off-site surveillance function was initiated in 1995 for domestic operations of banks. The primary objective of the off site surveillance is to monitor the financial health of banks between two on-site inspections, identifying banks which show financial deterioration and would be a source for supervisory concerns. This acts as a trigger for timely remedial action.

During December 1995 first tranche of off-site returns was introduced with five quarterly returns for all commercial banks operating in India and two half yearly returns one each on connected and related lending and profile of ownership, control and management for domestic banks. The second tranche of four quarterly returns for monitoring asset-liability management covering liquidity and interest rate risk for domestic currency and foreign currencies were introduced since June, 1999. The Reserve Bank intends to reduce this periodicity with effect from April 1,2000.

Corporate Governance

With a view to strengthening the corporate governance and internal control function in the banks, several steps have been initiated. Introduction of concurrent audit system, constitution of independent audit committee of board, appointment of RBI nominees on boards of banks, creation of a post of compliance officer, such are some steps. Besides, the Reserve Bank monitors the implementation of recommendations of Jilani Committee relating to internal control systems in banks on an on-going basis during the annual financial inspection of banks.

Initiatives and Directions

The Reserve Bank has taken several other supervisory policy initiatives. These include quarterly monitoring visits to banks displaying financial and systemic weaknesses, appointment of monitoring officers and direct monitoring of certain problem areas in house-keeping, etc. In addition the department provides secretarial support to the Board for Financial Supervision and acts as its executive arm. It is the BFS which evolves policies relating to supervision. It also attends to appointment of statutory central auditors / branch auditors for all banks and selected all India financial institutions and to complaints against banks. The department monitors cases of frauds perpetrated in banks and reported to it. The department as a one time measure, issued several guidelines to banks and all india financial institutions to enable them to become Y2K compliant.

Core Principles

Against the backdrop of banking sector reforms in India and the global focus on internal control and supervisory mechanism, the need for building a strong and efficient banking system comparable to the international standards cannot be gainsaid. A detailed study was carried out so as to ascertain gaps, if any, in implementing the 25 core principles of effective banking supervision enunciated by the Bank for International Settlements (BIS). Necessary steps have already been initiated to fill in the gaps, so as to make the regulatory as well supervisory system more sound and comparable to international standards.

Supervision over FIs

On the basis of the recommendations made by an in-house group, the monitoring of the financial institutions first started after 1990. This was done through prescribed quarterly returns on liabilities / assets, source and deployment of funds, etc. The objective of this monitoring was to obtain a macro level perspective for evolving monetary and credit policy, to assess the quality of assets of the financial system and to improve co-ordination between banks and FIs. In 1994, these institutions were brought under the prudential regulation of the Reserve Bank.

The Reserve Bank has adopted more or less, the CAMELS approach for regulation of Fis. Since FIs are vested with developmental role as welland with responsibility of supervision of other institutions, evaluation of their developmental, co-ordinating and supervisory role is also undertaken.

The newly created division in the department at present supervises and regulates ten select all-India financial institutions viz., IDBI, ICICI, IFCI, IIBI, Exim Bank, NABARD, NHB, SIDBI, IDFC and TFCI. With a view to having a continuous monitoring and supervision of these FIs, an off-site surveillance system has also been put in place.

Further, the division collects from LIC, GIC and UTI information relating to assets and liabilities and flow of funds for the purpose of overall assessment of the impact of the operations of FIs on the total flow of resources in the economy and for compiling new liquidity and monetary aggregates.