Letter of Transmittal
Deputy Governor
June 11, 2012
Dr. D. Subbarao
Governor
Reserve Bank of India
Mumbai
Sir,
Steering Committee for Review of Supervisory Processes in respect of Commercial Banks
I have immense pleasure in submitting the Report of the Steering Committee appointed vide Memorandum dated August 3, 2011 for Review of Supervisory Processes in respect of Commercial Banks in India. The report is intended to transform RBI's approach and processes for supervision of commercial banks for meeting the emerging challenges that the global banking system is faced with and lay down a roadmap for bank supervision for the coming decade. The inclusive nature of the Committee has ensured that the views of all stakeholders have been adequately incorporated. The report has benefitted immensely from the sagacity and expertise of the esteemed members of the Committee. I would like to add that a technical committee under the stewardship of Shri G. Gopalakrishna has helped us in refining the supervisory rating system for banks.
On behalf of the members of the Steering Committee, and on my own behalf, I sincerely thank you for entrusting this responsibility to us.
With kind regards
High Level Steering Committee for
Review of Supervisory processes of commercial banks in India
FOREWORD
“Until lions have their own historians, tales of the hunt will always glorify the hunter.”
An African Adage.
The High Level Steering Committee (HLSC) for Review of Supervisory Processes of Commercial Banks
in India, chaired by Dr. K.C. Chakrabarty, Deputy Governor, RBI and members comprising Shri B. Mahapatra,
ED, RBI, Shri Basant Seth, CMD (Rtd.), Syndicate Bank, Smt. Chanda Kochhar, CEO, ICICI Bank Ltd.,
Shri Diwakar Gupta, MD & CFO, SBI, Prof. Jayanth R. Varma, IIM Ahmedabad, Shri MBN Rao, CMD (Rtd.),
Canara Bank and Shri G. Jaganmohan Rao, CGM-IC, DBS (Member Secretary), gratefully acknowledges the
contributions made by the Technical Committee (Chaired by Shri G. Gopalakrishna, ED, RBI) represented
by Shri Paresh Sukthankar, Shri Ravi Duvvuru, Shri Shyamal Sinha from banks’ side and Shri Ajay Kumar
Choudhary and Shri Prakash Baliarsingh, GMs and Shri Prabhat Gupta and Shri N. Suganandh, AGMs from RBI side for providing inputs and suggestions for building a new supervisory rating framework. The HLSC
would also like to place on record its sincere appreciation for the invaluable contribution made by Shri P.
Vijaya Bhaskar, ED, RBI as a permanent invitee to the meetings of the Committee.
The HLSC also expresses its appreciation for the excellent intellectual and technical inputs provided
to the Committee by the officers of Department of Banking Supervision, Reserve Bank of India comprising
Shri Hauzel Thangzamuan, GM, Shri Sanjeev Prakash, DGM, Shri Rajesh Sharma and Shri Pronobesh
Barua, both AGMs and Kum Archana Shah, Executive Intern. The HLSC acknowledges with gratitude the
support provided by the secretarial team throughout the existence of the Committee in organizing the
meetings, collating information from various sources and in finalization of the draft Report. Finally, the
Committee would like to record its gratitude for the support and encouragement received from Dr. D.
Subbarao, Governor, RBI and thank him for addressing the HLSC members during one of the meetings of
the Committee.
The report is organized in seven chapters. Chapter 1 provides a perspective on the evolution of
the supervisory processes in India over the last two decades and traces the circumstances leading to
the constitution of the HLSC. Chapter 2 deals with supervisory approach, its philosophy, objectives and
recommends a Risk Based Approach to Supervision of Commercial Banks in India to meet the present and
emerging challenges. Chapter 3 describes the extant supervisory processes under the CAMELS framework
and approach to supervision under the proposed Risk Based Supervision (RBS) Framework. Chapter 4 covers the supervisory rating mechanism and introduces a risk focused supervisory rating framework
for measuring riskiness of the bank vis-a-vis RBI’s supervisory objectives. Chapter 5 deals with concepts
and processes of supervision for banking groups/ financial conglomerates and enumerates the approaches
for appraisal of group governance, group risk management, intra-group transactions and cross-border
supervision of foreign banks in India and Indian banks abroad. Chapter 6 examines institutional structure
and HR issues relevant for bank supervision and suggests measures for ensuring effective governance in
banks and for strengthening the supervisory resources within RBI for facing the new challenges of banking
supervision. Major recommendations of the Committee are summarized at the end in Chapter 7.
The Committee expects that the recommendations made in the Report would transform the approach
and processes for supervision of banks in India in line with the best supervisory practices & standards
in the global arena and facilitate a more efficient and effective supervisory regime ensuring safety and
stability of banking system in the coming decade.
Executive Summary
Banks occupy the pride of place in any financial system by virtue of the significant role they play in
spurring economic growth by undertaking maturity transformation and supporting the critical payment
systems. The specificity of banks, the volatility of financial markets, increased competition and diversification,
however, expose banks to risks and challenges. The protection of depositors’ interests and ensuring financial
stability are two of the major drivers for putting in place an effective system of supervision of banks. In the
wake of recurring bank failures and consequent financial crises over the last two decades, there have been
resolute attempts by bank supervisors across the globe to limit the impacts of bank failure and contagion
through ‘safety nets’ in the form of deposit insurance and liquidity support by Central Banks/ Governments.
An effective supervisory system is, however, critical for preventing bank failures by ensuring the safety and
soundness of banks.
Reserve Bank of India is entrusted with the responsibility of supervising the Indian banking system
under various provisions of the Banking Regulation Act, 1949 and RBI Act, 1934. Subsequent to the economic
liberalization since the 90s which also manifested in greater operational autonomy for banks and Financial
Institutions, RBI’s approaches to supervision of banks has also gradually shifted from a more intrusive
micro-level intervention towards prudential regulation and supervision in line with the international best
practices. An expert group (under Shri S. Padmanabhan) also conducted reviews of RBI’s supervisory processes
viz. systems and procedures relating to the statutory inspections during the 90s and recommended measures
for improving the efficiency and effectiveness of RBI’s approach to supervision of banks.
The last two decades had been characterized by increased integration of global financial markets and
cross-border banking activities, diversification of banks into other financial market segments, increased
complexity of products, processes and group structures. Though the banking landscape has changed
considerably, the supervisory approaches and processes within RBI have remained more or less stagnant
resulting in a mismatch between supervisory responsibilities and available resources necessitating a review
of the supervisory processes and rationalization of the organizational structure for bank supervision. The
existing supervisory framework for commercial banks in India has fared rather well over the years and drawn
praise from peer supervisory agencies, standard setters and the FSAP assessors for the tightly controlled
regulatory and supervisory regime. However, in view of the growing complexities in the banking business
and lessons from the recent financial crisis that has led a thorough overhaul of the global regulatory and
supervisory benchmarks viz. revised prescriptions for more resilient banks and banking systems (Basel III),
revised Core Principles for Effective Bank Supervision, Principles for Supervision of Financial Conglomerates
and planning for Recovery and Resolution of global systemically important banks, there is a felt need for a
relook at RBI’s extant supervisory processes and mechanism in order to make it more robust and capable
of addressing emerging challanges.
In light of the above, a High Level Steering Committee (HLSC) was constituted under the Chairmanship
of Dr. K. C. Chakrabarty, Deputy Governor for Review of Supervisory Processes for Commercial Banks with
representation from RBI, commercial banks and the academia. The Committee was mandated to review the
extant approaches, methodologies, processes/tools for onsite and off-site supervision, Supervisory Rating
& Stress Testing Frameworks and recommend measures for a gradual progression to a Risk Based Supervision
Framework. In accordance with the assigned mandate, the HLSC conducted a comprehensive review of the
extant approaches, systems and procedures, tools and methodologies for supervision of banks and is making
several recommendations as highlighted below:
Objective of Supervision
- Along with protection of depositors’ interests and ensuring financial health of individual banks/FIs, an
implicit overarching objective of RBI’s supervisory process should also be to ensure financial stability
and customer protection.
Approach to Supervision
-
Risk Based Supervision (RBS) which focuses on evaluating both present and future risks, identifying
incipient problems and facilitates prompt intervention/ early corrective action should be the approach
for bank supervision as against the present compliance-based and transaction testing approach (CAMELS)
which is more in the nature of a point in time assessment. RBS benefits the bank supervisor by optimizing
its use of supervisory resources and also helps the regulated entities in improving their risk management
systems, oversight and controls.
-
Since the success of RBS approach is highly incumbent upon a robust offsite surveillance system, any
manual intervention in the flow of supervisory data from the banks to RBI needs to be eliminated in
order to ensure quality/integrity of data.
-
Under RBS, the approach to on-site supervision changes whereby probability of failure and the likely
impact of failure of a bank rather than the volume of business determines the periodicity/intensity of
on-site inspection process. Thus, the banks assessed as having a low risk/impact profile would be
inspected only once in a 2 to 3 year cycle. However, irrespective of the supervisory stance/approach
determined in respect of a particular bank, a comprehensive report highlighting the financials, level/
direction of material risks, risk mitigants and a risk mitigation plan, wherever applicable, would need
to be prepared and put up to the Board of Financial Supervision on an annual basis.
-
Thematic reviews should be increasingly used as a tool of supervision whereby review of a particular
product, market or practice using a specialized team would be made to assess risks brewing within the
sector or at system levels for enabling prompt actions/measures.
Organizational Structure/Processes
-
In view of the fragmented set up for supervising different entities belonging to the same banking group,
the supervision of all group entities under the jurisdiction of RBI may be brought under a single
supervisory department. This would facilitate effective Consolidated Supervision and also provide a
single point interface for the bank within RBI.
-
A single point contact in the form of a ‘ Supervisory Relationship Manager’ should be created within
the Department of Banking Supervision to ensure efficient and effective communication between the
supervisor and the supervised entities.
-
For clarity of jurisdiction for the supervised entity and making the relationship /dealing desk an effective
single point of contact in the Department of Banking Supervision, the domains of regulation and
supervision should be firmly demarcated and any entity specific decision should only emanate from
the supervisory department.
-
The communication between the supervisor and the supervised entity should be treated as confidential
and should not be subject to any public scrutiny.
Supervisory Rating
-
Under the risk based approach to supervision, the supervisory rating would be a reflection on the risk
elements (inherent risk and control) and not an exercise in performance evaluation as is the case under
the CAMELS rating Framework. The supervisory rating exercise would aim at determining the overall
probability of failure of the bank in light of risks to which the bank is exposed, strength of control/
governance and oversight framework in place and available capital.
-
Based on the rating, the bank would be apprised of the direction/ trend of key risk groups along with
overall risk faced by it and a risk mitigation plan, comprising of need for improving controls, augmenting
capital and/or restructuring business.
Consolidated Supervision
- To improve the effectiveness of Consolidated Supervision of banking groups, it is essential to ascertain
and focus on the potential risks arising from the material group entities to the parent bank. In line with
the risk based approach to supervision of banks, the consolidated supervision of large and complex banking groups may be conducted by focusing on key risk areas within the group.
Corporate Governance
- To bring in more transparency and for making the Board /Top Management of the bank more accountable,
specific measures including recording of “Talking Minutes” of Board deliberations or video/audio
recording of the proceedings of Board and its various Committee meetings may be introduced.
Human Resources Development
- With a view to creating a pool of domain experts within RBI, a system of continuous movement of
people from RBI to external organizations i.e. commercial banks (in areas like risk management, financial
engineering, treasury operations, capital planning etc), accounting firms, academia, capital market,
brokerages, legal firms etc. and vice versa should be instituted. This needs to be encouraged through
well-defined career progression programme and made an integral part of HRM function within RBI.
CHAPTER 1
INTRODUCTION
1.1 As creators of money, depositories of public
savings, allocators of credit and conduits of the payment
system, the banks have a unique position in the
economy of any country. To bolster the larger public
interest, public policy for banks is put in place by the
government, the goals of which may vary depending
on the nature of economy and priorities of the
government.
1.2 Objectives of Supervision
1.2.1 Depositor protection and systemic risk are the
two main reasons that are normally cited for putting
in place a system of regulation and supervision of
banks. In the wake of financial crisis and bank failure
during the last two decades, there have been attempts
to limit the impacts of bank failure and contagion
through ‘safety nets’ in the form of deposit insurance
and the lender of last resort function by Central Banks.
While the safety nets are triggered during crisis
situations, supervision plays a vital role in preventing
the occurrence of a crisis situation or bank failure.
1.2.2 In the context of banking supervision, the
policy has to contend with the dilemma in choosing
the authority responsible for supervision of banks, the
ambit of its supervisory jurisdiction and its autonomy/
independence from the Central Government.
Theoretically, each of the possible options and choices
has its own merits and demerits, with no clear
evidences to suggest that any single option is a better
alternative. Different countries have adopted different
options best suited to their economic and political
environments and India too has adopted its own model
wherein bank supervision is entrusted to the Reserve
Bank of India (RBI) with adequate functional autonomy.
However, there is no unified supervisor for a variety of
financial services offered by different entities in the
country.
1.2.3 RBI’s inspection of banks under section 35 of
B.R. Act is undertaken as a follow up of the bank
licensing regulation and objectives as laid down in
Section 22 of the Act. The substantive objective of the
statutory inspections is to verify whether the conditions
subject to which the bank has been issued license to
undertake banking business [vide sub-section 3, and
for foreign banks also 3A of Sec.22] continue to be
fulfilled by them. Another implicit objective of bank
supervision is to ensure that the various regulatory
norms prescribed by the regulatory authorities are
being adhered to including financial soundness and
operational viability. The stability of the banking
system is an oblique aggregation of sound individual
banks which is rather altruistic.
1.3 Evolution of Supervision of Commercial Banks
in India
1.3.1 Subsequent to the economic liberalization of
the 1990’s, RBI has been pursuing a steady and cautious
approach towards banking liberalisation. This has been
evident in the implementation of the report of the
Narasimham Committee (1991) which granted
operational autonomy to banks and Financial
Institutions. Other reforms during the early 1990s
included: (a) shift in supervision from intrusive microlevel
intervention towards prudential regulation and
supervision (b) interest rate and entry deregulation (c)
adoption of prudential norms (d) establishment of the
Board of Financial Supervision (BFS) in the RBI (e)
diversification of activities by banks and (f) private
sector ownership of Indian banks. During the last
decade, the Indian banking industry has recorded a
compounded average growth rate (CAGR) of 18 percent
as compared to the country’s average GDP growth of
7.2 percent during the same period. The overall
development in banking industry has been
supplemented with greater efficiency and productivity
of the banking sector.
1.3.2 The Indian banking sector has two kinds of
scheduled banks i.e. Scheduled Commercial Banks (SCB)
and scheduled Co-operative banks. The SCBs can
further be classified into four types based on their
ownership and mandate as: i) Public Sector banks ii)
Private Sector Banks iii) Foreign Banks in India and iv)
Regional Rural Banks. All the SCBs are under the
supervisory jurisdiction of the Department of Banking
Supervision of RBI and are, thus, the primary subject
of deliberations of the Steering Committee.
1.3.3 Until the early 1990s, the focus of RBI’s
regulation of commercial banks in India was mainly on
licensing, minimum capital requirements, pricing of
services including administration of interest rates on
deposits as well as credit, reserves and liquid asset
requirements. Under such regulatory regime, banking
supervision had to focus essentially on solvency issues.
Since 1988 Basel-I Accord, however, RBI has been taking
steps to realign its supervisory and regulatory standards
with international best practices in a phased manner
taking into consideration the economic conditions of
the country. In this context, few expert groups have
conducted reviews of the supervisory processes viz.
systems and procedures relating to the statutory
inspections, during the last two decades.
Working Group to Review the System of On-site
Supervision over Banks (Chairman: S. Padmanabhan,
1995)
1.3.4 The Group, while re-emphasising the primacy
of on-site inspection, recommended switching over to
a system of ongoing supervision. It recommended a
strategy of periodical full-scope ‘on-site examinations’
supplemented by an in-house ‘off-site monitoring
system’ in between two statutory examinations. The
Working Group recommended orienting supervision
for enforcement of correction of deviations. It was
decided that the periodic and full scope statutory
examinations should concentrate on core areas of
assessment, viz., (a) financial condition and performance
(b) management and operating condition (c) compliance
and (d) summary assessment in line with the
internationally adopted capital adequacy, asset quality,
management, earnings, liquidity and systems (CAMELS),
including a CAMEL based rating model with systems
and controls added to it for Indian banks and a CACS
model (capital adequacy, asset quality, compliance,
systems and controls) for foreign banks. Subsequently,
examination of ‘liquidity’ was added to christen the
model as CALCS. The periodic statutory examinations
were to be supplemented by four types of regular and
cyclical on-site assessments, viz., targeted appraisals,
targeted appraisals at control sites, commissioned
audits and monitoring visits.
Working Group on Consolidated Accounting and
Other Quantitative Methods to Facilitate Consolidated
Supervision (Chairman: Vipin Malik, 2001)
1.3.5 The Working Group (WG) recommended a
framework for Consolidated Supervision which
included preparation of Consolidated Financial
Statements (CFS) for improving public disclosure,
Consolidated Prudential Reports (CPR) for supervisory
assessment of risks which may be transmitted to banks
(or other supervised entities) by other group members
and application of certain prudential regulations like
capital adequacy and large exposures / risk concentration
on a group-wide basis.
Working Group on Monitoring of Systemically
Important Financial Intermediaries (Financial
Conglomerates) (Convener: Smt. Shyamala Gopinath,
2004)
1.3.6 The Working Group recommended
establishment of a monitoring system for Financial
Conglomerates (FCs). The WG laid down norms for
identification of a SIFI and its group entities as also a
format for capturing financials, Intra-group transactions
and exposures amongst group entities, collective
exposures on a group-wide basis and a mechanism for
inter-regulatory co-operation on issues related to the
identified FCs.
Experiment with RBS
1.3.7 As a part of the monetary and credit policy for
2000-01, the Reserve Bank of India had announced its
intention to move towards a Risk-based approach to
banking supervision. Risk Based Supervision (RBS)
envisaged the monitoring of banks by allocating
supervisory resources and focusing supervisory
attention according to the riskiness of each banking
institution. The Department of Banking Supervision
conducted two rounds of pilot runs of RBS covering a
few banks however, due to lack of adequate Risk
Management Architecture in banks, the RBS experiment
was discontinued.
1.4 Bank Supervision Process in India
1.4.1 The Reserve Bank of India has been entrusted
with the responsibility of supervising the Indian
banking system under various provisions of the Banking
Regulation Act, 1949 and RBI Act, 1934. This
responsibility is discharged through the Department
of Banking Supervision (DBS), which covers 87
commercial banks (including local area banks) and 4
select financial institutions (FIs) through its 16 Regional
Offices.
Supervisory Set up
1.4.2 The Board for Financial Supervision (BFS) which
came into being in November 1994 is the apex body
responsible for Consolidated Supervision of the
financial sector under the jurisdiction of RBI (commercial
banks, financial institutions and non-banking finance
companies). The Governor, RBI is the Chairman of the
BFS, and the Deputy Governor in charge of banking
regulation and supervision, is nominated as the Vice-
Chairman. The other deputy governors of the Reserve
Bank are ex-officio members and four directors from
the Central Board of the RBI are co-opted as members
for a term of two years. DBS acts as the secretariat of
the BFS which normally meets once every month to
deliberate various supervisory issues and approve the
rating of banks.
1.4.3 Prior to 1993, the Department of Banking
Operations & Development (DBOD) looked after the
supervision and regulation of commercial banks. In
December 1993, the Department of Supervision (DoS)
was carved out of the DBOD with the objective of
segregating the supervisory role from the regulatory
functions of RBI. The supervisory role of the Department
of Banking Supervision includes:
-
Planning for and conducting onsite
inspection,
-
Off-site surveillance, ensuring follow-up
and compliance,
-
Determining the criteria for the
appointment of statutory auditors and special auditors and assessing audit
performance and disclosure standards and
monitoring of major financial sector frauds
-
Exercising supervisory intervention in the
implementation of regulations, which
includes recommendation for removal of
managerial and other persons, suspension
of business, amalgamation, merger /
winding up, issuance of directives and
imposition of penalties.
While majority of the offsite supervision work
is undertaken from central office of DBS, the regional
offices of the department at various locations across
the country assist the Central Office by undertaking
AFI of banks and inspections of branches under their
respective jurisdictions.
Supervisory Processes
Offsite Supervision
1.4.4 As a part of the supervisory strategy, an off-site
monitoring system for surveillance over banks was
operationalized in RBI in March 1996. As a tool for “early
warning signals” the Offsite Surveillance and Monitoring
System (OSMOS) plays a key role in identification of
risks and monitoring banks on a continuous basis.
OSMOS consists of a set of 28 structured returns that
capture prudential and statistical information of banks
at periodical intervals. The information gathered is
populated into the OSMOS database , enabling the offsite
supervisor to undertake prudential analysis of
bank’s Capital, Assets, Earnings, Liquidity, etc. on both
solo and consolidated basis. Issues of concern arising
out of such analyses are flagged for consideration of
Top Management and also placed before the BFS. Along
with bank specific analysis, certain macro-level analysis
of the banking sector are also undertaken periodically
to assess and identify the risks and potential concerns.
Various statistical tools are deployed to extract and
analyse data for use in various RBI publications and for
policy inputs.
Onsite Supervision
1.4.5 On-site supervision of banks is a key process
in the overall supervisory framework. The on-site supervision involves an Annual Financial Inspection
(AFI) of banks that is presently modeled around the
CAMEL (Capital Adequacy, Asset classification,
Management, Earnings appraisal, Liquidity) framework
with an additional parameter of Systems and Controls
(modified as CAMELS for Indian commercial banks and
CALCS for Foreign banks). The present CAMELS is a
transaction-based examination with a matrix used for arriving at a rating of each of the CAMELS components
to give a final adjusted supervisory rating for each bank.
Of late, the AFI has been giving considerable importance
to risk management system in banks. Based on the
concerns highlighted by the AFI reports and discussions
with banks, a Monitorable Action Plan (MAP) is drawn
for compliance and a memorandum covering supervisory
concerns from AFI including supervisory rating is compiled for perusal of the BFS. In addition to AFI, a
few need based targeted inspections and scrutinies at
the banks are also undertaken.
Box 1: OF-SITE SUPERVISION |
Significant changes /modifications to the OSMOS since its inception: |
Year |
Significant Changes/ Additions |
1994 |
The setting up of an off-site surveillance function in the Department based on a prudential / supervisory reporting framework. |
1995 |
Tranche I Returns |
Periodicity |
Report on Asset liability and off balance sheet exposures (ALE) |
Monthly |
Report on Capital Adequacy – Basel I (RCA) |
Quarterly |
Report on Operating Results (ROR) |
Quarterly |
Report on Asset Quality (RAQ) |
Monthly / Quarterly |
Report on Large Credits (RLC) |
Quarterly |
Report on Connected lending (RCL) |
Quarterly |
Report on Ownership and Control (ROC) |
Half yearly – March & September |
Other Returns: |
|
Bank Profile (RBP) |
|
1999 |
Tranche II Returns |
Periodicity |
Statement of Structural Liquidity (STL) |
Monthly |
Statement of Interest Rate Sensitivity (IRS) |
Monthly |
Statement of Maturity and Position (MAP) |
Monthly |
Statement of Interest Rate Sensitivity – Forex (SIR) |
Monthly |
Other returns: |
|
Balance Sheet Analysis (BSA) |
|
DSB (O) returns |
|
Report on Asset Liability and Exposures (ALO) |
Quarterly |
Report on Structural Liquidity (SSL) |
Quarterly |
Report on Problem Credits (PCI) |
Quarterly |
Report on Large Exposures (RLE) |
Quarterly |
Report on Country exposures (CEM) |
Quarterly |
Report on Profitability (ROP) |
Quarterly |
Report on Frauds (ROF) |
Quarterly |
2000 |
A quarterly return on “Subsidiaries / JV / Associates” under DSB Returns (RIS) (Tranche II)
The OSMOS database upgraded to RDBMS environment with built in data-warehousing component. |
2001 |
Local Area Banks were instructed to submit 7 DSB returns (Tranche I). |
Box 2: Onsite Supervision |
Year |
Significant changes |
Pre 1992-93 |
Financial Inspections (FI) – at intervals ranging from two (for private & foreign banks) to four years (for public sector banks); these included visits to Head Offices, Controlling Offices and a cross-section of branches for making detailed assessment of all aspects of a bank’s operations.
Annual Financial Reviews (AFR) in respect of public sector banks (except SBI). These visits covered Head Office and a quarter of the Controlling Offices only and relied mostly on the Management Information System (MIS) in banks. |
1992-93 |
Annual Financial Inspections (AFI) with main accent on the assessment of the bank’s financial position. Biennial management audits by Senior Officials to look into the non-financial aspects i.e. Management and Systems.
The time span of inspection including preparation of reports was reduced to maximum period of 4-5 months. |
2011 |
The format of the inspection report made more focused, by bifurcating into Main report and Explanatory Note. Foreign banks with market share of asset size less than 0.1% and Financial Institutions having no systemic risks to be inspected only once in two years.
Formation of twelve financial conglomerates for continuous supervision by Central Office of DBS. |
Supervisory Rating
1.4.6 A rating system for domestic and foreign banks
based on the CAMELS model combining financial
management, systems and control elements has been in place since July 1998. The present rating of banks is
done on a 10-point scale i.e. A+ through D in ascending
order.
1.5 Need for revisiting the supervisory processes
1.5.1 The existing supervisory framework for
commercial banks in India has fared rather well over
the years and drawn praise from peer supervisory agencies, standard setters and the FSAP assessors for
the tightly controlled regulatory and supervisory
regime, consisting of higher than minimum capital
requirements, frequent hands-on and comprehensive
onsite inspection processes. The FSAP assessors have
also noted that the Indian banking system remained
largely stable during the global financial crisis. However,
the growing complexities of the banking business in
general and the emergence of a number of large banking
groups with significant cross-border and cross-sector
presence in particular, are rendering the system
increasingly vulnerable to the threat of ‘contagion’.
Such contagion, arising from within and outside the
country coupled with complexities in the structures of
the banks, risks from their non-banking businesses and
need to comply with the stringent global capital
adequacy and risk management standards in a timebound
manner, pose immense challenges before the
banking supervisor.
Box 3: Significant changes in Supervisory Rating adopted by the RBI over the years |
Year |
Methodology |
1996 |
S. Padmanabhan Committee (1995) recommended for Indian banks, six rating factors viz. Capital Adequacy, Asset Quality, Management, Earnings, Liquidity, Systems and Controls (i.e. CAMELS), and for Foreign banks, four rating factors viz., Capital Adequacy, Asset Quality, Compliance, Systems and Controls (i.e. CACS) |
1999 |
Circular on CAMELS and CACS rating framework including components rating and composite rating issued. As per the circular, each of the component was to be rated separately on a scale of 1 to 100 in ascending order of performance. Each of these six Components was to consist of several parameters with individual weightage i.e. 100 marks distributed among these parameters – depending on their relative importance in that particular Component.
Composite rating of ‘A’ to ‘D’ to be computed calculating weighted average of Components Ratings. |
2002 |
The rating model of CACS modified to include the component ‘Liquidity’. |
2006 |
In order to appreciate nuances between two different banks having the same composite rating and to show granularity in the rating, 3 rating scales each were introduced under A, B and C making a total of ten rating scales including D. |
2007 |
The parameters and markings in respect of ‘Earnings Appraisal’ component of the rating revised for CAMELS |
2009 |
The parameters and markings in respect of ‘Earnings Appraisal’ component of the rating revised once again only for CAMELS. |
1.5.2 While the banking landscape has witnessed
considerable changes over the last two decades, the
supervisory resources and processes within RBI have
remained more or less stagnant. This has resulted in a
mismatch between supervisory responsibilities and
available resources necessitating a review of the
supervisory processes and rationalisation of the
organisational structure for bank supervision.
Additionally, lessons from the financial crisis which
have manifested in the form of new regulatory and
supervisory benchmarks like Basel III, revisions to the
Core Principles for Effective Bank Supervision and
Principles for Supervision of Financial Conglomerates,
Recovery and Resolution Plans for systemically
important banks also need to be factored in for making
the supervisory processes and mechanism at RBI more
robust and capable of addressing emerging issues.
1.5.3 The present supervisory approach / processes
followed by RBI are not adequately risk focused nor are
these forward looking to the required extent. The
present off-site supervision and contacts/ discussion
with bank management are not leveraged to gauge the
importance/riskiness of the banks in the banking
system. Unlike most jurisdictions, supervision in India
mostly revolves around the on-site inspection process,
which is found to be rather ad hoc i.e. without any documented supervisory action plan for the bank. The
outcomes of these supervisions, though shared with
the concerned banks as supervisory reports, do not
result in an effective and monitorable risk mitigation
plan. The present supervision (i.e. transaction based)
is generally done independently without adequately
utilising the work done by the external /internal
auditors of banks, resulting in undue duplication of
efforts.
1.5.4 The current supervisory rating framework (i.e.
CAMELS /CALCS) while attempting to gauge the
performance of the banks, enables the supervisors to
understand the micro-perspectives and facilitates
arriving at a “rating” for the banks through a scoring
pattern, but does not incorporate any forward looking
elements thereby not reflecting the true market
standing of the entity. Further, the factors influencing
the rating awarded to the bank and the implications of
the awarded rating are not shared with the banks.
1.5.5 Due to lack of legal framework / bilateral MoUs
and also coordination among domestic regulators and
overseas regulators /supervisors, the consolidated
supervision / cross border supervision of bank group
in general and large complex banking groups in
particular (SIFIs) has not been carried out to the
required extent.
1.6 Constitution of HLSC
1.6.1 With a view to addressing some of the
shortcomings mentioned above and also other
institutional issues pertaining to the bank supervisory
processes, a High Level Steering Committee (Chairman:
Dr K C Chakrabarty, Deputy Governor of the RBI) was
set up by the Governor, RBI in August, 2011 as per the
Monetary Policy announcement of 2011-12, to assess
the adequacy of RBI’s supervisory policies, procedures
and processes and suggest enhancements to the
supervisory policies comparable to the global standards.
The Committee has been given twelve months time to
submit its report.
Terms of Reference:
-
To review the approach to supervision so as to
make the process more effective and useful to
the supervised entities as well.
-
To examine the extant onsite supervisory
examination approach, methodology and
processes / tools including review of the
Supervisory Rating & Stress Testing Framework.
-
To examine the extant offsite supervisory
methods including the efficacy of offsite
surveillance system.
-
To review the adequacy of Prudential Supervisory
guidelines and Supervisory Review Process
under Pillar 2 and recommend measures for
moving over to a forward looking Risk Based
Supervision Framework.
-
To examine the extant methods for conducting
Consolidated Supervision and recommend
measures for enhancing the intensity and
efficacy of supervision of Systemically
Important banking groups (SIBs) / conglomerates
on a continuous basis as also strengthening
cooperation / coordination with domestic
regulators.
-
To recommend measures of strengthening the
extant cross-border supervisory cooperation
processes including the provisions / coverage
of the bilateral MoUs and outline an approach
for establishing Supervisory Colleges for Indian
banks.
-
To assess the adequacy of the institutional
structure for carrying out supervisory function,
especially human resources aspects (need for
creating specialists with appropriate skill sets
for examining specific risk areas viz. credit,
market, liquidity etc.) use of technology vis-a-vis
supervisory objectives and the extant
complexity of banking products / processes.
-
To suggest a framework for feedback mechanism
and review of supervisory processes and make
recommendations to address the gaps identified
in the extant supervisory process.
-
To consider / make recommendations on any
other matters relating to or incidental to the
above.
1.7 Benchmarking for future
The Indian financial system will further grow
not only in size but also in complexity in the years to
come. As competition gains further momentum, banks
are expected to get more integrated with the economyboth
domestically and globally. As the activities of the
banking system expand, there would be a need to focus
on the organizational effectiveness of banks. In day to
day functioning and operation of the banks, the quality
and character of the bank management would play the
role of primary line of defense against banks’ potential
distress. In this context, the supervisors would need
to focus on strengthening management and management
systems within the banks. In this context, the
Committee’s recommendations would be a sort of
vision document for the supervisory processes and
standards to be followed by RBI during the next decade.
CHAPTER 2
SUPERVISORY APPROACH
2.1 Introduction
2.1.1 It is universally agreed that there is no optimal
structure or process for supervising banks and
consequently the approach and processes for bank
supervision differ considerably from country to
country. The approach for supervising banks is
determined primarily on the stage of development of
the financial system, number of banks, their size and
complexity of the banking system. Few other factors
which influence the supervisory approach in a
particular jurisdiction are the ownership pattern,
reliability of the public disclosures by the banks and
the availability of technological and human resources
for conducting supervision.
2.1.2 The Core Principles for Effective Banking
Supervision issued by the Basel Committee on Banking
Supervision (BCBS) provides an implicit framework for
the regulation and supervision of banks. The recently
revised “Core Principles for Effective Banking
Supervision” put up for comments by the BCBS
succinctly set the benchmark for the bank supervision
process under its Principle 8:
“An effective system of banking supervision
requires the supervisor to develop and
maintain a forward-looking assessment of the
risk profile of individual banks and banking
groups, proportionate to their systemic
importance; identify, assess and address risks
emanating from banks and the banking system
as a whole; have a framework in place for early
intervention; and have plans in place, in
partnership with other relevant authorities, to
take action to resolve banks in an orderly
manner if they become non-viable.”
2.1.3 On the approaches to supervision, the BCBS
paper delineates that supervisory objectives could be
achieved through a greater focus on effective risk-based
supervision, early intervention and timely supervisory
actions. The paper further suggests that the supervisors
should assess the risk profile of banks in terms of the
risks they run, the efficacy of their risk management
and the risks they pose to the banking and financial
systems. As per BCBS, the risk-based process targets
supervisory resources where they can be utilised to the
best effect, focusing on outcomes as well as processes
moving beyond passive assessment of compliance with
rules.
2.1.4 Whatever approaches the bank supervisors
follow or the tools they use, the underlying objective
is to ensure that the banks operate in a safe, transparent
and efficient manner and the broader goal of financial
stability is achieved. While the protection of depositors
/customers is subsumed in this broader objective,
sometimes, it is specifically tasked as such.
2.2 Elements of good supervisory practices
2.2.1 The approaches adopted by the supervisors in
various jurisdictions differ broadly on the basis of
degree of intrusiveness and intensiveness. An IMF Staff
Note “The Making of Good Supervision: Learning to
Say No” has identified being intrusive, skeptical but
proactive, comprehensive, adaptive and conclusive as
some of the attributes of a good supervisor. The note
has also identified the ability and the will to act as two
pillars that support good supervision.
2.2.2 The essential features of an effective bank
supervisory regime could be summarized as under:
-
Assesses compliance with rules and
regulations and adherence to safe and
sound banking practices;
-
Sensitive to evolving macro-economic and
regulatory changes;
-
Responsive to the emerging risks at
individual banks;
-
Clearly diagnoses the risk profile of each
bank and ensure that banks have
appropriate risk management systems
with a strong internal control and external
audit mechanism;
-
Conducts supervision on a consolidated
basis – Appropriately assessing the risks
posed by all significant lines of business,
including those subject to the primary
supervision of another regulator and
maintain effective coordination with the
other sectoral regulators;
-
Efficient use of available supervisory
resources by allocating the greatest
resources to the areas of highest risk; and
-
Maintains an adequate pool of trained
supervisory personnel with appropriate
skill- sets.
2.3 Supervisory Methods/Tools
2.3.1 Ongoing banking supervision typically consists
of a differentiated mix of off-site surveillance and onsite
examinations. Off-site monitoring involves
analysing and reviewing periodic financial and other
information relating to banks’ activities by the
supervisor. These regulatory reporting requirements
generally cover balance sheet and profit and loss
statements, information on capital and liquidity levels,
asset quality and loan loss provisions, profitability etc.
The on-site inspections traditionally involve
examinations by specialized supervisory staff for a
hands-on assessment of qualitative factors such as
management capabilities and internal control
procedures that cannot be adequately captured in
regulatory returns. In aggregate, it culminates in
assessment of risks and suggestion of a risk mitigation
plan.
2.3.2 The most commonly used approach in
supervising banks has been transaction testing and
compliance checking with a focus on ensuring that the
rules laid down for safety and soundness are adhered
to. An excessive focus on detecting non-compliance,
however, could undermine the efforts required for
understanding the key risk drivers and the flaws in risk
management practices of banks. Further, this approach
is invariably backward looking and tends to be
unmindful of the risks brewing in the bank in particular
and the economy in general.
2.3.3 While this approach worked well when the
banking business remained more traditional - taking
deposits and making loans, the spectacular change
witnessed over the last decade on account of financial
innovation, increased globalisation and the growing
use of modern technology as service delivery channels
- has undermined its relevance. New products and
services embedding technological innovations are some
of the complexities that the bank supervisors have to
increasingly contend with. The exponential growth of
the off-balance sheet items and introduction of complex
products such as derivatives and securitization has
complicated the turf for the supervisors and banks
alike. Another development that has necessitated a
review of the supervisory stance has been the
emergence of financial conglomerates with considerable
cross-border and cross-sector activities. Thus, while on
the one hand the boundaries between financial sectors
have become increasingly blurred, the inter-linkages
between various markets have increased on the other.
2.3.4 In view of these developments, the traditional
approach to banking supervision has become inadequate
both in context and focus. In order to counter these
growing challenges efficiently, the bank supervisors
needed to evolve robust and effective processes in order
to continually discharge their assigned mandate. The
supervisory response to these growing challenges has
been to develop a risk-focused approach that enables
them to assess and track changes in a bank’s risk profile
on an ongoing basis and to generate early warning
signals for enabling timely supervisory intervention.
This response has been supplemented by underscoring
the need for developing effective risk-management
systems and structures in banks for management and
oversight of risks. The underlying philosophy of the
risk-focused, risk-based, or risk-oriented approach to
supervision is to make a rigorous assessment of risks
in the banks’ books and as far as practicable assign
supervisory resources to the entities and part of their
businesses which pose the biggest risks. To effectively
identify and measure the risks emerging from crossborder
and cross-sector operations of the banks, the
supervisors have embarked on a consolidated
supervision approach, the efficacy of which, however,
came under serious questioning during the recent
global financial crisis.
2.4 Approaches to Bank Supervision in India
2.4.1 The Banking Regulation Act, 1949 (BR Act)
provides the legal framework for regulation and
supervision of banks in India. This statute, together
with some provisions in the Reserve Bank of India Act,
1934, State Bank of India Act, 1955, State Bank of India
(Subsidiary Banks) Act, 1959 and Banking Companies
(Acquisition and Transfer of Undertakings) Acts, 1970
& 1980, empowers the Reserve Bank of India (RBI) to
prescribe standards and monitor liquidity, solvency and
soundness of banks, so as to ensure that depositors’
interests are protected at all times.
2.4.2 An annual on-site financial inspection of banks
under Section 35 of the BR Act has been the main
instrument of supervision employed by RBI. The
supervisor also conducts an off-site monitoring of the
banks through the Offsite Monitoring System (OSMOS)
and various other returns prescribed (under Section 27
of the BR Act).
2.4.3 The on-site inspection of banks is meant as a
follow-up of the bank licensing regulation laid down
in section 22 of the BR Act. Section 11 of the BR Act
prescribes a minimum level of paid-up capital and
reserves to be maintained by banks in India and RBI’s
inspections evaluate the real net worth or real/
exchangeable value of paid-up capital and reserves held
by the banks as on a reference date. The substantive
objective of the statutory inspections is to verify
whether the bank continues to fulfill the conditions
subject to which the bank has been issued license to
undertake banking business. These conditions include:
-
the bank has the “ability to pay its present
or future depositors in full as their claims
accrue” (i.e. it is solvent and has adequate
liquidity);
-
the bank “has adequate capital structure
and earning prospects”;
-
“the affairs of the (banking) company are
not being, or are not likely to be, conducted
in a manner detrimental to the interests
of its present or future depositors”; and
-
“the general character of the management
of the bank is not prejudicial to the public
interest or the interest of its depositors”
(i.e. it has sound operational systems and
adequate controls operated by a prudent
management).
2.4.4 Besides the provisions for inspection of banks
contained in Section 35 of the BR Act, certain other
sections of the said Act also empowers the RBI to carry
out inspection of banks for specific purposes viz. for
determining a bank’s eligibility for a license to carry on
banking business in India [Section 22(3)], for certifying
that the concerned banking company is unable to pay
its debts preceding its winding up [Sections 38(4) and
44(1)], for determining the intrinsic or realistic value
of shares preceding the amalgamation of two banks
and for verifying whether the amalgamation
arrangement is detrimental to the interests of
depositors or to the affairs of the bank and conduct of
directors in the event of such amalgamation [Sections
44A and 44 B].
2.4.5 A review of the system of on-site supervision
of the banks by RBI was undertaken by a Working Group
headed by Shri S. Padmanabhan in 1995. On the basis
of the recommendations of the Working Group, a
modified supervisory rating mechanism for the banks
was introduced. While for the banks incorporated in
India, six factor rating namely CAMELS (i.e. Capital
adequacy, Asset quality, Management, Earnings,
Liquidity, Systems and controls) was used, for the
foreign banks operating in India the rating factors were
CALCS (i.e. Capital adequacy, Asset quality, Liquidity,
Compliance and Systems and controls).
2.4.6 As a strategy for moving towards continuous
supervision, the 1995 review had also recommended
that by way of supplementary vehicles collateral to and
in between statutory, full-scope inspections, following
types of on-site assessment and review exercises may
be carried out:
-
Targeted appraisals: detailed examination
of specific portfolios at periodic intervals;
-
Targeted appraisals through examination
of books, records, management information
system (MIS) at the control site for the
Indian operations & appraisal of overseas
branches through a visit to the International
Banking Division of the bank’s Head Office
in India;
-
Commissioned audits: examinations of
specific areas by external auditors; and
-
Monitoring visits: short visits to banks by
RBI inspectors for follow-up or review of
selected areas of concern.
However, these four supplementary vehicles
have sparingly been used.
2.5 RBI’s experience with Risk Based Supervision
2.5.1 Reserve Bank of India has continuously aimed
at improving the efficiency and efficacy of its supervisory
processes in line with the changes in the operating
environment. Realizing the need for a continuous
monitoring of the banks through off-site analysis of
critical data impacting their risk profiles, conducting
targeted on-site inspections and making early
supervisory interventions, Reserve Bank of India
initiated a pilot program for supervision of select banks
under the Risk-based approach during the supervisory
cycle of 2003-04. The pilot studies were also continued
during supervisory cycles of 2004-05 and 2005-06. The
main objectives of these pilot studies were:
-
To assess the level and direction of various
risks in the bank concerned and compare
the position with the CAMELS based- AFI
findings;
-
To study the level of preparedness of the
banks in regard to risk management
practices;
-
To build a pool of experienced inspecting
officers well conversant with the Risk
based approach of supervision; and
-
To back-test the efficacy of the RBS
framework.
2.5.2 These pilot studies were conducted in addition
to the normal CAMELS based Annual Financial
Inspection process. Some of the major findings of these
pilot studies were the following:
-
Banks had gained considerable experience
in preparation of risk profile document
which was central to the RBS process as it
enabled the supervisors to focus on target
banks or targeted areas of banks.
-
The quality and integrity of data inputs
was an area of concern.
-
The senior management of the banks had
not fully appreciated the importance of
risk management systems as an integral
part of business processes in their banks.
While some of the banks had risk
management framework for various risks,
identification/ measurement/ controlling
of risks and use of the risk assessment was
not made an integral part of the decision
making function in most banks.
-
Although an implementation of Risk Based
Internal Audit (RBIA) system had happened
in all banks covered under pilot study , the
system which was extremely crucial for
the success of RBS, had not stabilized.
-
The risk mapping for the banks covered
under the pilot study under RBS was
largely in alignment with the assessment
made under CAMELS suggesting that
CAMELS and RBS are compatible
supervisory approaches.
2.5.3 Based on the pilot studies, it was concluded
during 2006-07, that the banks in India were not ready
for a full-scale roll out of RBS as they needed some more
time for putting in place appropriate risk management
systems and operationalising risk based internal audit.
This Committee is mandated to examine various
options and recommends implementable approach and
processes of banking supervision to ensure effectiveness
of bank supervision in a globalized environment.
2.6 Views of the Committee
General
2.6.1 The supervisory approach adopted by RBI for
commercial banks has served it reasonably well and
instances of bank failures have been minimal and the
depositors’ interests have been well protected in the
midst of occasional challenges. However, in view of the
changed ground realities reflected in growing size,
complexity and new risks inherent in bank’s balance
sheets, increasing conglomeration and growing
internationalisation of the Indian banking system, RBI’s
supervisory approach needs to be revamped. Even
while the supervisory turf has become increasingly
complex, over the same period, a commensurate
development in the quantity and quality of the
supervisory resources has not happened.
2.6.2 Against this backdrop, there is a need to make
diligent, accurate and judicious judgment about the
risks facing the supervised entities so as to initiate an
appropriate and immediate supervisory action. To fulfill
the above objectives, RBI in its role as the bank
supervisor, needs to fully understand the risk profiles
of the banks on an on-going basis and focus on areas
of potential risks facing each institution so that a
forward-looking supervisory action plans may be
prepared and implemented. In this context, while the
need to persist with a baseline supervisory oversight
for all the entities need hardly be overemphasized, it
is imperative for the supervisor to be risk-focused and
judiciously employ the available resources so that the
key risks are identified and managed. This would entail
benchmarking the supervisory process/approach to the
global best practices and make a move towards a
forward looking risk-based approach to supervision
from the comparatively more resource-hungry,
transaction-testing and compliance-oriented approach
in vouge at present.
Objectives of Supervision
2.6.3 Principle 1 of the Basel Core Principle for
Effective Supervision sets out the promotion of safety
and soundness of banks and the banking system as the
primary objective for banking supervision. Some
jurisdictions additionally assign other responsibilities
like depositor protection, consumer protection,
financial stability, financial inclusion, etc for their
banking supervisors, provided these are not in conflict
with the primary objective.
2.6.4 The various statutory provisions, which
empower RBI to conduct supervision of banks, require
RBI to prescribe standards and monitor liquidity,
solvency and soundness of banks, so as to ensure that
depositors’ interests are protected at all times. RBI, in
its role as a banking supervisor is also responsible for
promotion of financial stability and protection of
consumers. However, RBI’s success in effectively
discharging these additional responsibilities are closely
intertwined with the safety and soundness of the
banking system and therefore do not result in any
conflict with its primary objective of depositors’
protection and promoting safety and soundness of the
banks/ banking system.
2.6.5 RBI has issued guidelines directing the banks
to ensure quality service to their customers through
setting up of Customer Service Committees and
instituting customer grievance redressal mechanism.
Further, RBI has also institutionalised a Banking
Ombudsman Scheme which provides a system of
expeditious and inexpensive resolution of customer
complaints on account of deficiency in banking services.
Ensuring fairness to customers, transparency in banks’
pricing and positioning of products/ services etc. has,
however lacked adequate supervisory focus over the
years which is reflected in growing number of
complaints at the offices of the Banking Ombudsman.
In this context, the Committee firmly believes that
customer protection should also be one of the core
objectives of supervision.
2.6.6 The Committee is aware that the objectives of
RBI’s supervisory processes enshrined in the regulatory
framework set out for the banks, are not explicitly
articulated at present. The committee believes that an
explicit articulation of supervisory objectives would
render the supervisory planning process, including an
assessment of the need for supervisory resources, tools
and methods, more effective and purposeful. Such
articulation would also facilitate fair evaluation of
supervisory effectiveness against stated supervisory
objectives. The Committee, thus, recommends that
protection of depositors’ interests, promotion of
financial health of banks/FIs and consequently
promotion of financial stability and customers’
protection should be articulated as overarching
objectives of RBI’s supervision.
Degree of intrusiveness of supervision
2.6.7 Presently, RBI conducts annual on-site
examination at banks apart from taking up targeted
scrutinies /appraisals for examining specific issues.
Formal meetings with the CEO and the senior
management of the banks after the Annual Financial
Inspections and at quarterly intervals constitute other
structured interface with the banks. For the banking
groups identified as Financial Conglomerates, a halfyearly
meeting with the CEOs of the major group
entities is held. Such formal interactions with the
supervised entities make the presence of the supervisor
felt on an ongoing basis.
2.6.8 The Committee is of the view that the
supervisor should not only be proactive in ensuring
compliance but also be more intrusive if the risk
management in a particular bank is perceived to be
ineffective. In this context, the Committee observes
that the banks’ business plans, the planning process
and the strategies to achieve the planned targets do not
receive adequate supervisory focus at present.
2.6.9 While concurring that the level of intrusiveness
in the affairs of a bank should be risk based, the
Committee recommends that the supervisory
assessment should begin with an appraisal of a bank’s
business plans (covering targets, strategy & efforts),
planning process and the attendant strategies so as to
capture the banks’ strategic risk and also use this
assessment as a yardstick for measuring the efficacy of
the management. The supervisory assessment should
also factor in deviations in a bank’s business plan and
strategy from the industry standards/averages and
reasons attributed by the management for such
deviations. The objective of the supervisor’s review
would not, however, be to question the business
strategies adopted by a bank, but to evaluate the extent
to which the bank management is involved in
formulation of the strategy and measures contemplated
to mitigate the attendant risks.
Reliance on external auditors
2.6.10 In some supervisory jurisdictions, external
auditors are commissioned to undertake a full on-site
examination or to review specific areas of operations
within a bank. The external auditors also independently
conduct annual statutory audits of the accounts of the
bank as well as its compliance with accounting
procedures and best practices. These provide an
additional assurance to the supervisor about the bank’s
financial position. Several bank examiners use these
audit reports and the compliance by the banks to the
recommendations made by their external auditors as
an important supervisory input.
2.6.11 The Committee is of the view that for improving
the effectiveness of the supervisory processes, it is
essential to eliminate the duplicity of efforts by various
stakeholders. It noted that while banks were subject to
transaction-level internal and external audits, the
supervisors also conduct detailed transaction testing
leading to duplication. In this context, the Committee
suggests that the inputs from reports of the internal
and external auditors should be utilised by the
supervisors for off-site assessment and also form a basis
for onsite examination.
2.6.12 With the stabilisation of Core banking solution
in all banks, the committee opines that the branch audit
of public sector banks may be dispensed with or
drastically curtailed in the future. Wherever focused
attention is required, the supervisor could commission
special audits in the banks to probe into specific areas
of concern.
2.6.13 On the extent of reliance to be placed on the
work of the statutory auditors of the banks, the
Committee noted that the quality of bank audit needed
improvement and stringent qualifying requirements
should be imposed on audit firms that are assigned
external audit functions at banks. The committee
recommends that the peer review of auditors should
be made mandatory for quality assurance purpose. The
Committee considers it necessary to make a realistic
assessment of the “Role & Effectiveness of the Auditors”
and the extent of reliance that the supervisor could
place on such information. Accordingly, it recommends
that RBI and the statutory auditors should jointly work
towards a formal code to enlist the mutual expectations,
documentation requirements, information sharing
requirements etc.
2.6.14 On the issue of whether the same audit firm
should be engaged for auditing the operations of the
entire banking group, the Committee is of the opinion
that in view of the need for a fair and consistent
approach and for ensuring accountability, it is desirable
to the extent possible that group audit should be carried
out by a single audit firm/ group of audit firms that are
tasked to audit the bank. The Committee also notes
that in view of the fragmented nature of audit firms in
India, this may not be feasible at present, but if the
supervisor has to place substantial reliance on auditors’
work, this could be a necessary pre-condition that need
be ordained for future.
Comprehensiveness of supervision
2.6.15 RBI’s Consolidated Supervision of banks is
limited to off-site assessment of the compliance with
some prudential requirements (capital adequacy, single/
group exposures, capital market exposure on a groupwide
basis) for consolidated banks. Intra-group /related
party transactions are also assessed for compliance with
arms length requirements during on-site inspections.
In view of the growing trend towards conglomeration
by the Indian banks & its gradual integration with the
global financial markets, the Committee is of the view
that it is necessary for the banks to focus on the risks
that emanate from their domestic non-banking
subsidiaries and the overseas banking subsidiaries/
branches. Accordingly, the supervisory efforts should
also be comprehensive and be geared towards assessing
risks for the parent banks from all its constituents. In
this context, the Committee recommends that the
supervisory focus should shift towards Consolidated
Supervision of banking groups.
2.6.16 The effectiveness of Consolidated Supervision
is incumbent upon sound understanding of the
financial position and risks, solvency, management and
control mechanisms for the banking group as a whole.
For banks having cross-border presence, it can be
achieved through sustained co-operation from other
host supervisors. While RBI has signed MoUs with some
of the overseas supervisory authorities for information
sharing purposes, the Committee considers that for an
effective Consolidated Supervision of Indian banking
groups with sizeable overseas presence, it would be
worthwhile to establish and host supervisory colleges.
2.6.17 Similarly for improving the information flow
on the non-bank subsidiaries of the banks, the
Committee is of the view that it is important for RBI to
have an effective co-operation and information sharing
mechanism with the other sectoral supervisors.
2.6.18 The Committee also takes note of the
fragmented set up within the RBI for supervising
different entities belonging to the same banking group.
In this context, the Committee recommends that in
order to facilitate effective Consolidated Supervision,
the supervisory processes for various entities forming
part of a banking group should be brought together
within a single supervisory department. The Committee
also recommends that a single point contact in the form
of a ‘Supervisory Relationship Manager’ (SRM) should
be created within the Department of Banking
Supervision to ensure efficient and effective
communication between the supervisor and the
supervised entities.
2.6.19 While debating on the level at which the
regulatory and supervisory departments within RBI
should converge the Committee is of the view that it
is an operational decision. However, the Committee
suggests that the domains of regulation and supervision
should be firmly demarcated and any entity specific
decisions should be the sole preserve of the supervisory
department. The Committee also noted that regulation
is generic in nature and is applicable to all entities
within the sector. To elaborate, prudential regulation
covers the sector as a whole and regulatory prescriptions
applicable as such to the sector are disseminated in
public space. Therefore, the transactional regulation
and regulatory approvals at the entity level are best
avoided by regulatory department. This is essential
both for clarity of jurisdiction for the supervised entity
and for making the relationship /dealing desk an
effective single point of contact in the Department of
Banking Supervision. The Committee further
recommends that the communication between the
supervisor and the supervised entity is absolutely
confidential and should not be subject to any public
scrutiny.
Proposed Approach to Supervision
2.6.20 The growing complexities within the banking
sector in India are manifest in significantly expanded
balance sheets, complex products, processes and
practices, and increased integration with the global
financial system. Consequently, the supervisor has to
be fully conversant with the risks inherent in the banks
and the incipient risks building up in the banking
system at all times leading to a need for monitoring
the banks closely and continuously. To achieve the
above objective, the Committee recommends that RBI’s
supervisory methods should be realigned to enable a
realistic assessment of the potential risks which the
banks may face. In other words, the supervisory tools
should be geared towards assessing on a forward
looking mode, the business and strategic risks facing
the institution and its ability and preparedness to
mitigate these risks.
2.6.21 The philosophy of risk-based supervision is
built around evaluation of risks and identification of
incipient problems for ensuring that the individual
banks initiate corrective action much before the
problems could undermine their safety and soundness.
Under a compliance based approach, supervisory
activities focus on the financial position of the
supervised entities at a given point in time (stock).
Risk-Based Supervision (RBS) on the other hand is a
dynamic process (flow) where the emphasis is more on
understanding and anticipating the possible risks the
supervised entity will be facing when executing its
business plan going beyond its current financial
situation. For example, under the RBS approach, the
supervisor while considering the bank’s plan to
introduce new products would focus more on the
effects on the bank’s capital if the initiatives were
unsuccessful or, even, too successful! Compliance
focuses more on whether the bank currently has
sufficient capital and follows the rules that, it is
assumed, are sufficient to ensure the objectives of
supervision are met. In that sense, RBS can be said to
be more preventive and forward looking as well.
2.6.22 Globally, RBS has gained recognition as the
preferred approach to the traditional approach which
focuses largely on determining the current financial
condition of a bank, based on historical financial data
and on quantifying a bank’s current problems through
the use of audit-like examination procedures. By
contrast, RBS focuses on qualifying problems by
identifying poor risk management practices and
emphasizing the need for understanding and assessing
the quality of risk management systems put in place
by the banks for identifying, measuring, monitoring
and controlling risks in an appropriate manner. RBS,
thus benefits not only the bank supervisors, but also
the regulated banks by way of improved risk management
systems and oversight. It must, however, be
acknowledged that it is impossible to eliminate all risks
in a bank and consequently, the supervision is not
aimed at eliminating risks but seeking to mitigate them.
While practicing a risk based approach to supervision,
the supervisors also undertake a certain measure of
risk by focusing more on the banks which pose biggest
risks to the supervisory objectives.
2.6.23 The bank supervisors favour an approach that
would help them focus and dedicate supervisory
resources to identify higher risk banks and areas of
greater risk within the banks. Once those high risk areas
and the banks exposed to such risks are identified,
supervisory focus would turn towards assessing those
risks and looking for ways to mitigate them. The key
to effective RBS is to identify primary risks affecting a
bank and to evaluate the significance of those risks for
the bank. Once this is done, supervisory resources can
be deployed more efficiently to address those identified
risks. RBS, thus, meets the supervisor’s need to
rationalize the use of scarce supervisory resources.
2.6.24 The RBS approach is also consistent with the
international best practice standards such as Basel II
and the Basel Core Principles. For instance, Basel II
requires banks to design and implement effective risk
management systems. The Committee has noted
following benefits of a risk focused approach for
supervision of banks:
-
Improved understanding of the risk
profiles of banks, their business and of the
quality of management;
-
Early identification of emerging risks at
individual banks and on a sectoral basis
i.e. the risk contagion;
-
Enable to indicate the direction of risks,
possible to anticipate future scenarios and
hence a forward-looking capability to
initiate supervisory measures where
needed;
-
Optimum utilisation of the supervisory
resources with a greater focus on material
risks and risk management processes at
banks.
2.6.25 The Committee believes that migration to risk
based approach to supervision would facilitate
improving the culture of risk management and
oversight in the banks’ management and therefore,
RBI’s supervisory programme should be drawn up by
focusing on the risks posed by individual banks/
banking groups and supervisory resources should be
allocated in line with their risk profiles.
2.6.26 The Committee notes that a minimum level of
acceptable risk management systems (RMS) in the
banks is an essential prerequisite for migration to a risk
based approach to supervision. It also took note of the
prevailing inadequacies of the IT systems, Management
Information System and the risk management systems
in majority of the Indian banks and apparent lack of
incentives for the management of the public sector
banks to improve the risk management systems (RMS)
in their banks. The Committee is firmly of the opinion
that addressing such inadequacies is central to the
success of a risk-based supervision and in order to
exhort the bank management to improve their RMS
introducing regulatory disincentives like cap on further
expansion of branches, balance sheet etc., could be a
probable approach.
2.6.27 The committee recommends a Risk Based
Supervisory framework for the Indian banks and has
indicated ingredients of a baseline risk management
system that should be in place at each bank before the
Risk Based Supervision could be rolled out. The
Committee also suggestes that full-scale RBS could be
implemented across the banking industry from the
supervisory cycle of 2013.
Supervisory Methods /Tools
2.6.28 In a risk-based supervisory framework, both
onsite examination and off-site surveillance feed into
one another as they are mutually interdependent. RBS
is, therefore, designed and implemented as a process
encompassing both on-site examination and off-site
surveillance of banks.
Off-site Supervision
2.6.29 The ability of the supervisors to conduct a
meaningful supervision on a ‘close and continuous’
basis with a risk-focus is dependent upon capturing
and analysing detailed information about the banks,
their profile, culture, risk tolerance, operations and
environment on a dynamic basis. The Committee
recommends that under the proposed risk-based
framework, the off-site supervision should be
substantially strengthened to provide inputs for the
onsite visits. It also notes the quality and integrity of
the data submitted by the banks to the supervisors is
not reliable/ inconsistent and as such there is a need
to eliminate any manual intervention involved in the
flow of data from the banks to RBI. The Committee also
recognises a pressing need for instilling some discipline
in the banks to ensure data integrity.
2.6.30 The offsite supervisory process includes
preliminary risk assessment of the banks based on
captured data flows pertaining to their business plan/
strategies, group structure, financial statements,
compliance and internal audit/plans and reports,
observations of external auditors etc. This together
with macro-economic factors and market intelligence
inputs (received from rating agencies, industry groups,
consultants etc.) are key inputs to decide on the scope,
focus, resources and time for the onsite supervisory
visits. The offsite supervisory process, thus, envisages
that considerable time should be spent to analyse offsite
data gainfully before embarking on an on-site
examination exercise. To enable the banks to be
sufficiently prepared for the onsite supervisory visit
and facilitate an efficient on-site examination, the
supervisors may share the scope and focus of the
supervisory visit to the banks in advance.
On-site Examination
2.6.31 With the preliminary risk assessment of the
banks being done off-site, under the RBS regime, the
focus and orientation of the on-site visits would
undergo a significant change from the present
supervisory practice. Under the RBS approach, the
onsite visits should focus more on filling gaps in
information gathered during off-site analysis,
conducting validation checks onsite of the risk
aggregates to understand the extent of specific risks
and also sectoral risks with a potential for contagion,
conducting follow-up on issues identified from previous
assessments and undertaking a limited review through
interaction with the top management. Onsite inspection
could also be used to verify the accuracy of the
information submitted by the banks as part of
regulatory reporting and compliance with banking
regulations and accounting standards. The Committee
is of the view that the level of risk rather than the
volume of business should be the determinant of the
periodicity of on-site examination and accordingly
recommends that while the periodicity of the onsite
supervisory examination /reviews for all large and risky
banks could be annual, the on-site inspection of the
smaller banks with a lower risk profile should be
conducted only once in a 2 to 3 year cycle.
Thematic Reviews
2.6.32 Apart from the regular monitoring of banks, it
is also necessary that supervisor undertakes thematic
review of a particular product, market or practice using
a specialised team to assess whether any risks are
brewing within the sector or at system levels. Such
thematic reviews help in discerning the quantum and
nature of risks over a cross-section of banks and enable
taking prompt actions to address them. Some indicative
areas for such focused reviews may include observance
of KYC compliance, management of money laundering
risks, approaches for management of interest rate,
exposure to sensitive sectors, investment and liquidity
risk, NPA, pension liability, compensation practices etc.
Interactions with the Top Management of banks
2.6.33 Under the continuous supervision mode, the
need to interact with the management will depend on
the aggregate risks posed by an institution to the
supervisory objectives at a given point in time. In this
context, the present system of holding quarterly
discussions with the Top Management of all banks as
a matter of routine may be replaced with formal
interactions, the periodicity of which is determined by
the supervisor based on its risk assessment for a
particular bank /banking group.
In this context, a mechanism for periodic
interaction of the supervisor with the Top Management
of the banks at a common platform, for deliberating on
issues affecting the banking sector as a whole, would
mutually benefit the supervisor and the supervised
entities.
CHAPTER 3
SUPERVISORY PROCESSES
3.1 Introduction
Legal Basis
3.1.1 The Banking Regulation Act, 1949 (BR Act)
provides the legal framework for regulation and
supervision of banks. This statute, together with some
provisions in the Reserve Bank of India Act, 1934, State
Bank of India Act, 1955, State Bank of India (Subsidiary
Banks) Act, 1959 and Banking Companies (Acquisition
and Transfer of Undertakings) Acts, 1970 & 1980,
empower the Reserve Bank of India (RBI) to prescribe
standards and monitor liquidity, solvency and
soundness of banks, so as to ensure that depositors’
interests are protected at all times. An off-site
monitoring of banks through various regulatory returns
(prescribed under Section 27 of the BR Act) and periodic
on-site inspection of banks constitute the main
supervisory activities of the RBI to ascertain that the
banks are in compliance with the licensing regulation
laid down in section 22 of the BR Act.
3.1.2 Certain other provisions of the BR Act also
mandate RBI to carry out inspection of banks for specific
purposes viz. for determining a bank’s eligibility for a
license {Section 22(3)}, for winding up {Sections 38(4)
and 44(1)}, for amalgamation {Sections 44A and 44 B}
etc. Apart from above, Section 35 (1) (a) of BR Act
empowers the RBI to cause a scrutiny of any banking
company and its books of accounts. While section 35
of the BR Act confers upon RBI the general authority to
conduct inspection of books and accounts of banks, the
Act does not mandate on-site inspection of banks on
an annual basis.
3.2 Evolution of Supervision of Commercial Banks
3.2.1 An Annual Financial Review (AFR) of public
sector banks was introduced following the
recommendation of the Pendharkar Committee in the
mid 1980s. These AFRs were based on reports submitted
by the banks themselves. The Padmanabhan Committee
recommended merging the AFRs with the financial
inspection paving the way for Annual Financial
Inspections for all banks beginning from the year 1991.
The Narasimham Committee (1991) recommended
separating regulation and supervision. Partly in
compliance with the recommendations of Narasimham
Committee and also based on the recommendations of
the Joint Parliamentary Committee, a Board for
Financial Supervision (BFS) as a Committee of the
Central Board of RBI was set up in 1993. At the same
time, supervision was also separated from regulation
by creating Department of Supervision (DoS) (later,
Department of Banking Supervision ‘DBS’ in 1997) as
a separate department carved out of the Department
of Banking Operations and Development (DBOD).
3.2.2 The second Padmanabhan Committee (1995)
recommended a system of ongoing supervision of the
banking system. To this end, an Off-site Monitoring
and Surveillance System (OSMOS) was introduced in
1996 to complement the on-site inspection. The new
strategy of supervision was based on the CAMELS
model focusing on Capital, Assets, Management,
Earnings, Liquidity and Systems and Controls. The role
of auditors was enhanced and broadened to include
concurrent audits and certification of the quality of
banks’ compliance with various regulatory prescriptions.
Over the years Prompt Corrective Action (PCA)
framework, Consolidated Supervision, Supervision of
Large and Complex banks/Financial Conglomerates etc.
were inducted to augment and strengthen the
supervisory processes. Risk-Based Supervision was
introduced in 2003 on a pilot basis but the same was
never formally launched.
Present Regime of RBI Inspection
3.2.3 The main objective of banking supervision by
the RBI under various statutory provisions is to ensure
that depositors’ interests are protected at all times. RBI
also has the implicit role of ensuring financial stability
and consumer protection. RBI has adopted CAMELS
framework (i.e. Capital adequacy, Asset quality,
Management, Earnings, Liquidity, Systems and
controls) for supervision of commercial banks in India.
RBI’s supervisory processes include evaluation of
banks’ performance by way of an on-site Annual
Financial Inspection broadly with reference to the
following:
-
Banks’ financial condition and performance
highlighting Asset Quality, Solvency and
Capital Adequacy, Earnings Performance
and Liquidity;
-
Management and operating conditions
focusing on Management (board and
senior management), Systems and Internal
controls, including risk management
strategies;
-
Compliance to Regulations including
integrity of reporting and compliance to
guidelines.
Based on the above evaluation, a Summary
assessment is made which mainly highlights the
supervisory concerns and identifies areas for corrective
action. The AFI findings are recorded under CAMELS
framework and a supervisory rating of the public/
private sector banks is done on the basis of scores
obtained by them under relevant parameters of
CAMELS. The foreign banks operating in India are rated
under the CALCS (i.e. Capital adequacy, Asset quality,
Liquidity, Compliance and Systems & Controls) model.
3.3 Supervisory Process
3.3.1 The current supervisory processes broadly
involve three stages viz. inspection planning for the
banks, conduct of AFIs (onsite) and follow-–up and
monitoring. Off-site supervision through Offsite
Monitoring and Surveillance System (OSMOS), Prompt
Corrective Action (PCA) (i.e. based on pre-determined
trigger points on CRAR, Net NPA and RoA), Risk Profile
Templates, supervisory discussions supplement the
AFI process. Supervisory Review and Evaluation Process
(SREP) has been recently introduced as supervisory
tool. The same supervisory processes are applied
uniformly across all the supervised entities.
Inspection Planning
3.3.2 The inspection cycle begins with drawing of
the Annual Perspective Plan (APP) for the Annual
Financial Inspections (AFIs) of the banks in the Central
Office of the Department of Banking Supervision in
consultation with the Regional Offices. The APP is
prepared based on considerations of asset size,
availability of supervisory resources etc.
3.3.3 To complement the Head Office inspection a
representative cross-section of branches and controlling
offices are also covered under AFI. Criteria for selection
of branch/ controlling offices include, inter alia, asset
size and off-balance-sheet exposure of the branches in
such a manner to ensure coverage of 30% gross advances
in respect of public and private sector banks and 60%
in respect of foreign banks. Further, 1% of the rural
branches and OBU of each bank are also generally
covered every year. The Principal Inspecting Officers
select the branches / controlling offices / LHOs of SBI
for inclusion in the inspection. For few foreign banks
and new private sector banks, branches are not
inspected if information regarding loan appraisal,
monitoring etc. are centralized and not held at the
branches. The APP relies on information and inputs
from various sources including inspection reports of
branches /controlling offices / Local Head Offices,
previous AFI reports /compliance, OSMOS returns,
minutes of Quarterly Discussions (QDs), RBI’s Nominee
Directors, etc. to arrive at the strengths, weaknesses
and other areas of concern regarding the functioning
of the bank.
On-site Inspection
3.3.4 The CAMELS / CALCS based on-site inspection
(AFI) is normally conducted with reference to the last
audited balance sheet date. The onsite inspection is
transaction- based, compliance-focused and involves
review of systems and procedures prevailing in the
bank. The on-site AFI is conducted by a team of RBI
Inspecting Officers led by a Principal Inspecting Officer
(PIO).
Inspection Report, Supervisory Rating and Follow up
3.3.5 The findings of the AFI are formally discussed
by the AFI team with the CMD / CEO of the bank. Areas
of divergence remaining unresolved are indicated
separately in the draft Inspection Report. At the
respective Bank Monitoring Division of Central Office,
the Report is further processed. This involves final
resolution of significant divergences, identification of
Monitorable Action Plan (MAP), issue of supervisory
letter to the bank, conduct of AFI discussion with top
management of the bank, preparation of BFS
memorandum on the findings of the AFI, finalization
of rating and approval by BFS. The BFS approved
supervisory rating is then communicated to the bank.
3.4 Supplements to Current Supervisory Process
Off-site Supervision
3.4 1 With the introduction of off-site returns
(submitted by the banks online on Off-site Monitoring
and Surveillance System – OSMOS) in March 1997, the
supervisory system changed to a judicious mix of both
on-site inspection and off-site surveillance and
monitoring.
3.4.2 Analysis of off-site returns are carried out
individual bank wise, bank group wise, peer group wise,
industry wide, sectoral level etc. along with sensitivity
to fluctuation in interest rates. The basic framework
for analyses of off-site returns is on the CAMELS
pattern. However, data on management / systems &
control are not collected except for a number /aging of
unreconciled entries in inter-branch adjustment
account and accounts with banks in India / overseas.
3.4.3 On the basis of the off-site returns, macro level
analysis including Aggregated Micro-Prudential
Indicators (AMPIs) of the health of individual financial
institutions and Macro-Economic Indicators (MEIs)
associated with financial system soundness, are also
carried out. These reviews are broadly based on -
Macroeconomic Indicators, Capital Market, Interest
Rate Scenario, CRR/SLR, Forex Market and Market
Movements, Corporate Profitability, etc. Some of these
Macro analyses are published in various journals of the
RBI, while others are solely for the consideration of Top
Management and BFS.
Discussions with the Banks’ Management
3.4.4 In addition to AFI discussion, a system of
Quarterly Informal discussions (QIDs) with the
executives of the banks on issues emanating from
analysis of off-site returns, position of compliance of
the findings of AFI, new products introduced by banks,
etc was introduced in 1999. As these discussions
become an important supervisory tool over the years,
the same was made a formal forum for interaction
between banks and DBS in 2009. Further, for the
banking groups identified as Financial Conglomerates,
there is a system of half-yearly meeting with the CEOs
of the major group entities.
Risk Profile Templates (RPT)
3.4.5 As part of pilot RBS, a Risk Profile Templates
(RPTs) was developed by RBI to assist the banks in
assessing their business and control risks in a structured
and comprehensive manner. In 2006 the RPTs were
revised and presently cover assessment of five business
risk areas (viz., Credit risk, Market risk, Liquidity risk,
Operational risk and Group risk); two control risk areas
(viz. Management risk and Compliance risk) and Capital
and Earnings. These RPTs are being updated by the
banks on a quarterly basis.
Prompt Corrective Action (PCA)
3.4.6 To guard against regulatory forbearance and to
ensure that regulatory intervention is consistent across
institutions and in keeping with the extent of the
problem, a framework for PCA was developed. The PCA
framework links the regulatory action to quantitative
measures of performance, compliance and solvency
such as CRAR, NPA levels and profitability. The PCA
framework based on identified trigger points including
serious deterioration in CRAR, Net NPA and RoA beyond
the tolerable limits could trigger supervisory action
resulting in placement of banks under supervisory
regime for closer monitoring and handholding.
3.5 Deficiencies / Gaps in the current supervisory
processes
3.5.1 The changes in the financial landscape coupled
with development in IT and financial engineering has
increased the complexity of the product offered by the
banks. Liberalization and globalization has significantly
enhanced the scope and domain of the banking
activities in India. Against this backdrop, it becomes
pertinent for the bank supervisors to keep themselves
abreast of the changing ground realities and equip
themselves for the emerging challenges. The Committee
notes that, while the present approach to the
supervision of banks has served the system rather well
over the last two decades, it has its own share of
deficiencies, some of which have increased in relevance
owing to the changed environment. Some of the
shortcomings identified by the Committee relating to
the present inspection processes are as under:
-
Inspection process follows a ‘One size fits
all’ / uniform approach for all banks
without due regard to either their risk
profiles or the impact of their failure may
have on Indian financial system.
-
Although OSMOS has been in place for
more than a decade, the desired
integration with the AFIs is yet to be
achieved. This is perceived to be a weak
link for ongoing / continuous supervision
of the banks.
-
Deficiencies connected with end use of
OSMOS include data gaps (i.e. OSMOS
presently does not capture the risk
parameters / limits), reliability and
integrity of the off-site data etc. Further,
many data duplications and manual
interventions are observed in the off-site
returns. Since these returns are compiled
manually without sufficient cross
validations before actual submission, a
large degree of data inconsistency is
observed vis-à-vis the data available in
the Core Banking Platform of the banks.
-
The scope and coverage of on-site
inspection is virtually identical for all the
banks. Since the supervision lacks a risk
focus, it results in inefficient allocation
of supervisory resources. Presently, the
Man hours consumed and time spent for
conducting on-site supervision of banks
in India is very high when compared to
similar assessments in other peer
jurisdictions.
-
Quarterly discussion held with the top
management of the bank by RBI is
observed to be a very rigid formal
structure and is not an event- driven
exercise.
-
The present AFI process does not use
thematic study or trend analysis in
respect of asset quality assessment,
earnings appraisal etc and hence is not
adequately geared for capturing proxies
to risks.
-
Although ICAAP is a key element of the
bank’s governance framework in matters
of capital adequacy assessment, bank’s
risk profile, quality of risk management
process, etc. assessment of ICAAP are not
factored in adequately before
commencement of on-site inspection.
-
SREP has not stabilized on account of
several reasons including lack of skill /
technical expertise.
-
Presently, the RPTs submitted by the
banks, though comprehensive, are very
voluminous and lack focus. This makes
comprehensive analysis of RPTs an
onerous exercise for the supervisors.
Data from various off-site sources are not
adequately leveraged to prepare for onsite
inspection processes.
-
Selection of bank branches for inspection
is done on ad hoc basis and not as per
risk assessment or findings of auditors
under the Risk Based Internal Audits
(RBIAs). Frequency of present AFI is also
dependent on availability or otherwise
of supervisory resources and not on risk
perception of the banks and hence not
risk-based.
-
Adequate attention has not been paid to
the overseas inspection of branches and
subsidiaries, in spite of rapid growth in
the cross-border assets of Indian banks.
-
Outsourcing of data centres of banks to
both on-shore and off-shore providers
have enhanced the risk perceptions from
such arrangements which are not
adequately assessed under present
inspection.
-
The outcomes of on-site inspections,
though shared with the concerned banks
as supervisory reports, do not result in
effective and monitorable risk mitigation
plans.
-
Due to lack of legal framework / bilateral
MoUs as well as coordination among
domestic regulators and overseas
regulators /supervisors, the consolidated
supervision of the banking groups are not
done to the extent it is required.
-
Current supervisory rating does not
capture the potential risks to which an
institution may be exposed.
3.6 Views of the Committee
3.6.1 With a view to addressing these deficiencies,
the Committee has recommended migration to Risk
Based approach to Supervision (RBS). The committee
is of the view that under the risk based supervisory
framework, the on-site inspection process would
benefit from the feedback loop through the offsite RPT
and MIS, as also by drawing upon inputs from the
banks’ auditors. The on-site inspection process would
also be integrated with thematic reviews and periodic
supervisory meetings with top management of banks.
The Committee is cognizant of the fact that the banks
in India possess varying degrees of advancements in
Risk Management Frameworks and therefore, it is of
the opinion that in banks with rudimentary risk
management structures, it would not be possible to
conduct RBS with immediate effect. In this context, the
committee recommends that a full-scale RBS may be
implemented across all commercial banks without
exception from the supervisory cycle of 2013.
Off-site Surveillance
3.6.2 The effectiveness of a risk based supervisory
process is fundamentally incumbent upon a robust
off-site surveillance mechanism. The essential
attributes of a strong Off-site supervisory process would
include being extensive, proactive and dynamic.
‘Extensiveness’ in respect of off-site supervision means
that the off-site supervisory returns encompass all
operations /activities of the bank/bank group including
risk elements as well as its mitigants. ‘Proactive’ offsite
supervision means being forward looking and
ensuring generation of early warning signals on
incipient risks, material to the activities of the bank
and enable the supervisor to initiate necessary
corrective supervisory actions promptly. A ‘Dynamic’
off-site supervision implies collection of comprehensive
data /returns as frequently as possible and performing
analysis of the same in between the supervisory cycles.
To enhance the effectiveness of the offsite supervision
over banks, the Committee recommends the following:
3.6.3 In order for the off-site surveillance system to
be effective and efficient, the monitoring should be
focussed on detecting and identifying risk elements
in areas not covered by present regulations. The system
should also facilitate collection/analysis of data for
conduct of thematic reviews. The peer-grouping for
thematic reviews should be based on functional aspects
and not on the ownership and size of the bank.
Data Integrity
3.6.4 The Committee acknowledges that accuracy
and integrity of data is central to the success of RBS
and therefore a differentiation between genuine data
errors and fabrication of data in the off-site returns
should be made and defaults should be considered for
appropriate penal action under the B.R. Act, 1949, and
the RBI Act, 1934. In case of any serious and deliberate
offences, disciplinary action should be considered.
3.6.5 A comprehensive and integrated application
IT tool facilitating the collection of financial data
(balance sheet, exposures, risk limits etc) as well as
non financial information (policies, internal /external
audit reports etc) should be put in place for effective
off-site supervision under RBS. In this context, the
Committee recommends that the Extensible Business
Reporting Language (XBRL) based reporting system
presently under implementation within RBI, may be
leveraged upon.
3.7 RISK BASED SUPERVISION (RBS)
Supervisory Processes under RBS
3.7.1 RBS is an ongoing process wherein risks of a
bank are assessed and appropriate supervisory plans
designed and implemented by the supervisor. The
frame-work consists of six key steps:
|
Steps |
Risk Based Tools |
1 |
Understanding the bank |
Bank Profile |
2 |
Assessing risks faced by the bank for supervisory purpose |
Risk Assessment / Matrix |
3 |
Scheduling and Planning Supervisory Activities |
Planning for supervisory actions / interventions |
4 |
Defining Examination Activities, on-site reviews and on-going monitoring |
Onsite Inspection – objective, scope, etc |
5 |
Inspection Procedure |
Onsite Inspection, conduct of SREP, offsite continuous supervision. |
6 |
Reporting findings and recommendations and follow-up |
Inspection Reports, Updating of the bank Profile. |
Bank Profile
3.7.2 A profile containing comprehensive yet concise
information about the bank should be prepared and
the same should be updated on an ongoing basis using
inputs from various sources including reports of
previous inspections /risk assessments, off-site
surveillance, management reports to board committees,
internal and external audits findings, periodic
discussions with bank’s management etc. Broadly, such
a profile should contain information on banks’
corporate structure, most recent financials including
capital structure material business lines and their
contributions, key risks/risk mitigants, key management
personnel, major findings of the most recent supervisory
assessment of the bank. The Supervisory Relationship
Manager, who is responsible to build and review bank’s
profile has to ensure that the same reflects current risk
profile of the bank at any given time.
Risk Assessment
3.7.3 In keeping with the philosophy of risk based
supervision, it is imperative that the supervisory focus
is firmly on the key areas of risks within a bank. The
risk assessment process involves updating bank related
information collected from various sources including
onsite supervision and comprehensively analyzing the
material risk and other concerns arising out of banks’
operations. The risks that are relevant from the
supervisor’s viewpoint need to be mitigated on a
sustaining basis through adequate procedural and
institutional mechanism. The objective of risk
assessment encompasses the following:
-
Determining the activities of a bank that
may create potential hazards to the
detriment of the supervisory objectives
and goals;
-
Determining the severity and impact of
the risks and the effectiveness of risk
management which would need
supervisory action;
-
Proposing corrective action, including risk
management system, capital and reserves
for mitigating the severity of risk and their
impact;
-
Devising supervisory programs of the bank
and monitor the implementation of
measures.
3.7.4 The committee is of the firm view that risk
assessment is the key to entire Risk Based Supervisory
Framework as the major supervisory actions including
resource allocation, coverage and intensity of the actual
on-site examination, supervisory intervention and the
capital adequacy determination are to be a function of
the risk profile of the bank which would be updated
based on the risk assessment.
3.7.5 Accordingly, it is essential that the Supervisory
Relationship Manager (SRM) undertakes an extensive
and holistic assessment of various material risks
(mainly credit, market, operational, liquidity and other
pillar 2 risks) that the bank faces as part of his/her risk
assessment of the bank. In order to ensure that the risk
assessment has been made in a comprehensive,
structured and comparable manner it is necessary to
have a common risk assessment template across banks.
In this context, while the major inputs for the risk
assessment would need to be drawn from the Risk
Profile Templates (RPTs), certain other inputs viz.
regulatory reports submitted under OSMOS, banks’
ICAAPs, deliberations with Management of the bank,
statutory/internal audit findings and market intelligence,
etc should also be factored in by the SRM. Reports from
previous year’s on-site inspections, targeted appraisals,
thematic reviews, supervisor conducted stress tests and
other information like macro-economic environment
should also inform the risk assessment process. In view
of the need for extensive supervisory judgement, the
risk assessment produced by the SRM should be
mandatorily subjected to internal validation by a
committee of senior supervisors for quality assurance/
consistency purposes.
3.7.6 The supervisory stance under the risk based
approach is determined from a matrix arising from the
probability of failure of the bank and the impact such
a failure may have on the financial system. Thus, risk
to twin supervisory objectives (preventing failure of
banks and stability of the banking system) may be
determined as follows:
Risk to Supervisory Objective = Probability of Failure x Impact of Failure |
Assessment of Probability of Failure
3.7.7 The risk assessment of the various risks
embedded in the banks’ business would be determined
based on the inherent prudential risks and prudential
risk control in place in the bank for each risk group.
The net risk for all the component risk groups would
be rated (using a scorecard template) on a continuous
scale (0 – 4) and would be aggregated into a single score
by assigning appropriate weights to each component
as under:
Risk Assessment Matrix |
|
Weights |
Risk
Net |
(85%) |
Risk OG
(15%) |
Risk inherent |
Risk control |
Oversight & Governance |
Risk Group |
Credit Risk |
30% |
70% |
30% |
Market Risk |
20% |
70% |
30% |
Operational Risk |
20% |
70% |
30% |
Liquidity Risk |
20% |
70% |
30% |
Pillar 2 Risk |
10% |
70% |
30% |
Illustratively,
The composite Risk Score which is a determinant
of the probability of failure of the bank would be used
to produce a Risk Index which together with the Impact
Index described below would be used to determine the
supervisory stance/approach.
Assessment of Impact of Failure
3.7.8 The impact of failure would need to be
appropriately determined on the basis of size (on and
off balance sheet) of the bank, its interconnectedness
with the other market players, lack of substitutability
(eg. level of dominance in the payment system) /
financial institution infrastructure, complexity etc.
IMPACT RATING |
Impact Parameter |
Indicators |
Rating
Scale |
Significant
Weight
(Indicative) |
Cross-jurisdictional Activity |
Cross-jurisdictional claims |
(0-4) |
10% |
Cross-jurisdictional liabilities |
|
|
Size
|
Total exposures as defined for use in the Basel III leverage ratio |
(0-4)
|
20%
|
Interconnectedness |
Intra-financial system assets |
(0-4) |
25% |
Intra-financial system
liabilities |
Wholesale Funding Ratio |
Lack of Substitutability/ Financial Institution Infrastructure |
Payments cleared and settled through payment systems |
(0-4) |
25% |
Complexity
|
OTC derivatives notional value |
(0-4)
|
20%
|
Securities held for trade
and available for sale |
Impact Rating |
|
(0-4) |
100% |
3.7.9 In this context, it needs to be highlighted that
both risk and impact behave non-linearly and therefore
the risk and the impact scores derived from the
templating exercise need to be appropriately scaled to
amplify the significance of a higher score . Generally,
all the supervisory jurisdictions which practice risk
based supervision, raise the risk and impact scores to
their 4th power to suitably discriminate between a low
risk/impact and a relatively higher risk/impact bank. A
graphical representation of the steps involved in the
determining the supervisory stance/approach is as
under:
|
|
3.7.10 Based on the supervisory approach /stance for
a bank determined by its position in the matrix, the
areas of supervisory focus for each bank during the
annual supervisory cycle would have to be worked out
by the SRM. He/she would determine the areas of
specific concerns requiring focused monitoring during
the supervisory cycle, nature, intensity and coverage
of the onsite examination, targeted appraisals,
supervisory resource/ expertise requirement etc. The
SRM would also need to periodically update the risk
profile of the bank in the light of new business activities
and modifications to products, processes and systems
carried out by the bank.
3.7.11 The supervisory stance/intervention of RBI
based on the position of the bank in the risk matrix
could be one of the four: “Baseline Monitoring”, “Close
Monitoring” “Active Oversight”, “Corrective Action”.
Each supervisory stance would be associated with
specific supervisory actions to be initiated by the
supervisor. The objective of the intervention process
is to enable the Supervisor to identify areas of concern
at an early stage and intervene effectively so as to
minimize losses. Indicatively, these intervention stages
and supervisory actions associated with each stage of
intervention could be on the following lines:
Planned Supervisory Activities
a) Baseline Monitoring: The banks falling within
this zone in the risk matrix are perceived to be
posing little risk to the supervisory objectives as
also their failures would have limited impact on
the financial system. The banks falling under this
zone are likely to be characterized by stable
financial condition and strong internal controls
and governance systems. Therefore, the supervisor
may not need to be overly concerned in respect
of these banks and limit its supervisory work to
a baseline offsite monitoring. Such banks should
be taken up for onsite supervision only once in
three years. However, as part of the annual
supervisory cycle for such banks, short-duration
visits may be made by one/two officers for
verification of the accuracy of the regulatory
returns and to study specific issues in one or more
risk areas/controls.
b) Close Monitoring: Banks falling under this zone
would be posing relatively higher risk to RBI’s
supervisory objectives and their failures would
have greater implication for financial stability.
These institutions are likely to be characterized
with modest financial condition and risk
management systems and controls and would
therefore need greater supervisory focus as
compared to baseline monitoring. The supervisory
actions in such banks should comprise enhanced
off-site monitoring of the bank with increased
frequency/granularity of reporting requirements.
The periodicity of on-site inspections in the banks
falling under this zone could be once in two years.
The management, Board of directors and external
auditor of the bank may be apprised by the
supervisor about the potential risks that the bank
faces and the action required to correct these
deficiencies. Further, the Supervisory Relationship
Manager could programme one or more short
duration on-site visits to look at specific risk areas/
control and also hold interactions with the bank
management on these issues.
c) Active Oversight: Banks falling under this zone
would be considered as posing significant risk to
RBI’s supervisory objectives and their failures
would have significantly higher impact on the
financial stability. As these banks are likely to be
vulnerable to adverse business and economic
conditions and may have ‘material’ safety and
soundness concerns, the supervisor would need
to have active oversight on these banks. The
supervisory actions in such banks should comprise
yearly on-site inspections covering the risk areas
judged as high/medium in the risk assessment
exercise. The bank’s external auditor may also be
given a mandate to enlarge the scope of the review
of the financial statements and/or to perform other
procedures and prepare a report thereon. RBI’s
examinations should also have extensive
transaction testing. The risk mitigation plan
prepared by the inspection team should be closely
monitored by the SRM for compliance by the bank.
The onsite visits could also be supplemented with
short-duration targeted appraisals/scrutinies for
assessing progress and interactions with
management.
d) Corrective Actions: Banks falling under this zone
would be considered as posing grave risks to RBI’s
supervisory objectives and their failures would
have severe impact on the financial stability. In
view of the large scale threat of potential failure
of these banks, the supervisor would need to put
these banks under continuous watch. This would
include commissioning external specialists or
professionals to thoroughly assess the quality of
loan portfolio, security, asset values, sufficiency
of reserves, etc. as also requiring the management
and the board of directors of the bank to consider
resolution options such as restructuring the bank
or seeking a prospective partner for merger,
amalgamation or takeover. RBI’s on-site inspections
in such banks would be on an annual basis with
wide coverage of the material risk areas coupled
with elaborate transaction testing. The reports
from external specialists could be used to direct
the management to consider corrective actions
which would be continuously monitored for
compliance.
3.7.12 Irrespective of the supervisory stance/approach
determined in respect of a particular bank, a
comprehensive report highlighting the financials, level/
direction of material risks, risk mitigants and a risk
mitigation plan, wherever applicable, would have to be
prepared and put up to the Board of Financial
Supervision on an annual basis.
3.7.13 While observing that the Risk Assessment was
critical for framing an appropriate supervisory
response, the Committee also acknowledges that the
exercise involved both quantitative and qualitative
assessments by the concerned supervisors. In order to
ensure consistency/standardization of supervisory
judgment across the banking system, the Committee
underscores the need for developing an objective risk
assessment template. It also acknowledges that the risk
assessment process requires a high degree of competence
and skill on the part of the supervisor to produce an
optimum Risk Matrix. Towards this end, the committee
desires that if needed, technical inputs from
professionals or specialists could be used to ensure that
the risk assessment process is robust, consistent and
conforms to the global standards. The Committee also
recommends that the process of Risk Assessment must
be documented in a supervisory manual and a gist of
the risk assessment process may also be shared with
the supervised entities.
Scheduling and Planning Supervisory Activities
3.7.14 Based on the risk assessment of the bank, the
SRM would be required to prepare a comprehensive
supervisory action plan for the bank. The supervisory
actions on the bank based on the perceived risk about
the bank, would range from an on-site inspection (full
scale or targeted) to only a continuous off-site
monitoring supervision during a particular year. In this
regard, the Committee is of the view that all banks,
irrespective of their risk profile/outcome of the risk
assessment exercise, should be subjected to an on-site
inspection at least once in three years. It is important
to ensure that the proposed supervisory action plan
for the bank is adequate and appropriate to its assessed
risk profile and would be able to address the assessed
deficiencies /concerns in a demonstrable manner. The
Committee is of the view that the supervisory action
plan should be shared /discussed with the bank’s senior
management. The supervisory planning and scheduling
for supervisory actions must facilitate optimum
allocation of supervisory resources to ensure timely
and effective conduct of supervision.
On-Site Inspection Objectives & Scope
3.7.15 Based on the supervisory plan of a bank, the
Supervisory Relationship Manager would prepare a
detailed note listing the key objectives and scope of the
on-site inspection process. Thus, the on-site inspection
would focus on specific areas of concern in a bank and
would include a thorough review of the bank’s internal
risk management systems, governance in that area and
an appropriate level of transaction testing commensurate
with the severity of assessed risk. Allocation of
supervisory resources including composition of the
inspection team, requirement of risk specialists,
duration of the inspection etc. would be decided based
on the objectives of the onsite inspection. It would be
imperative that the designated inspection team duly
completes all pre-inspection preparations including
thorough study of observations of the SRM in the risk
assessment document and analysis of relevant data/
information relating to the bank before commencing
the on-site inspection for an efficient, focused and
qualitative exercise. The Committee is of the view that
the supervisor may share the scope and focus of the
supervisory visit with the banks in advance so as to
ensure that the bank is aware of the data/information
requirement of the inspection team well in advance
and the process is conducted within a disciplined
timeline.
Inspection Procedure
3.7.16 In performing on-site examination, supervisors
would be guided by procedures as laid down in the
Supervisory Manual, which may be revised from time
to time. The procedure adopted should be tailored
based on the supervisory action plan. The focus of the
supervisors should be on adequately assessing
management’s ability to identify, measure, monitor,
and mitigate risks. The inspecting officers may use
advance business intelligence tools, vulnerability and
configuration assessment software etc. to achieve the
supervisory objectives. The outcome of the on-site
inspection should be a report indicating supervisory
issues or concerns related to the bank and should
include appropriate comments regarding deficiencies
noted in the institution’s risk management systems
and recommend concise, specific, time bound and
monitorable risk mitigation measures. The Committee
is aware that the coverage of Inspection report under
RBS would not be uniform, as presently obtaining under
CAMELS, on account of variance in the risk profile and
the risk category of the banks.
Supervisory Review and Evaluation Process (SREP)
3.7.17 Inadequate supervisory assessment can expose
the banking system to vulnerabilities and potential loss
of depositors’ confidence. The lessons from the recent
Global Financial Crisis have shown that certain
institutions failed due to certain risks embedded in
their products and processes even though they were
assessed by their supervisors as being adequately
capitalised and highly liquid. This underscores the
deficiencies in the supervisory capabilities to accurately
determine adequacy of capital as part of the supervisory
assessment. The underlying objective of the Pillar 2
process of the Basel II Framework is to ensure that the
a) Banks have a process (ICAAP) for assessing their
overall capital adequacy in relation to their risk profile
and a strategy for maintaining their capital level; and
b) Supervisors have to review and evaluate the banks’
internal capital adequacy assessments and strategies,
as well as their ability to monitor and ensure their
compliance with regulatory capital ratio and take
appropriate supervisory action. SREP follows the
principle of comprehensiveness (i.e. the capital
assessment should be driven by the supervisor’s
understanding of the legal, operating, and corporate
governance structure of the organization and its
primary strategies, business lines, risk management
and internal control functions).
3.7.18 Basel II framework has been made applicable
to all the banks in India since April 2009. As required
under the Pillar 2, the banks are submitting their Board
approved ICAAP documents, both at solo (global
position) and consolidated level, on an annual basis
and the supervisory authorities are required to subject
all banks to a SREP exercise and initiate supervisory
measures deemed necessary. So far, two rounds of SREP
exercise have been carried out by the supervisor (RBI)
on a pilot basis and it is observed that the ICAAP at the
banks and the SREP by the supervisor, have yet to fully
mature and stabilise.
3.7.19 The risk based supervisory framework for the
commercial banks in India being recommended by the
Committee is consistent with the objectives of the Pillar
2 requirements as the framework seeks to achieve early
identification of problems in banks and intervene
where appropriate. The Basel II Framework also
acknowledges that the bank’s capital assessment
process has to be appropriate to the nature, scope and
complexity of its activities which is also consistent with
the risk sensitive approach being recommended by the
Committee.
3.7.20 Under the proposed risk based supervision
process, the Committee recommends that the risk
assessment process mentioned above should be
leveraged upon in determining the level of supervisory
capital for each bank. Further, as part of the overall
supervisory activities, a holistic review of the ICAAP
involving a quantitative review of the inherent Pillar 1
risks (Credit, Market, Operational) and a quantitative /
qualitative review (to the extent possible) of Pillar 2
risks (all other risks that a bank is exposed to) should
be conducted. As part of the review, an overall
assessment of adequacy of bank’s capital targets, its
strategy and capacity for achieving and maintaining
these targets should be made.
Inspection Reports, Discussion with Bank and
Follow-up
3.7.21 The inspection process would entail supervisory
meetings with the CEO/Senior Management of the bank
on the issues and concerns arising out of the
inspections. Along with the inspection report, a time
bound Risk Mitigation/ Monitorable Action Plan (MAP)
should also be prepared and closely monitored for
ensuring speedy compliance. The compliance should
be monitored by the Supervisory Relationship Manager
on an on-going basis. The Committee recommends that
the extant quarterly discussion with the banks needs
to be replaced with structured meetings with bank
management, the frequency of which may be
determined in accordance with the assessed risk profile
of the concerned bank.
3.8 Continuing off-site Supervision
3.8.1 One basic tenet of the risk based approach is
to have a greater focus on institutions that are assessed
more risky/vulnerable by the supervisors. The
supervisory program in respect of more ‘risky’ banks
includes a mix of on-site supervision as well as off-site
surveillance comprising monitoring of vulnerabilities,
compliance to risk mitigation plan etc. However, the
judgment of a bank /institution as less risky does not
relieve/ absolve the supervisor from its supervisory
duties. Those banks which are considered potentially
less risky /vulnerable as per the supervisory risk
assessment, are to be subjected to an ongoing off-site
supervision commensurate with the level of assessed
risk.
3.9 Supervisory Rating
As part of the annual supervisory process for
each bank under RBS, a supervisory risk rating exercise
capturing the supervisory risk in a bank shall be
undertaken. It is envisaged that the proposed
supervisory rating would measure the ‘net risk’ in a
bank. This rating would convey a sense about the
‘riskiness’ of the bank as perceived by the supervisor.
The details of the proposed supervisory rating are
indicated separately under Chapter 4.
IMPORTANT SUPERVISORY TOOLS / PRACTICES
3.10 Stress Testing & Reverse Stress Testing
Stress Testing
3.10.1 Stress tests are forward-looking and dynamic
methods for determining the Capital requirement and
detecting weakness in the risk management process
of the bank. Therefore, under the risk based supervisory
approach, stress testing method should be given a
higher weight amongst the analytical toolset. Within
RBI, a macro level (top-down) stress testing of the
banking system is undertaken to identify the threats
and potential risks that may arise from environmental
or other financial markets. At present, single factor
sensitivity tests for assessing the impact of a range of
stress scenarios on the credit, interest rate, foreign
exchange rate, equity price and liquidity risks are
conducted on quarterly basis. Similarly, to assess the
resilience of the system to adverse macroeconomic
scenarios, stress testing analysis is carried out by the
supervisor. Two major groups of macro testing exercises
are conducted: one based on a multivariate regression,
and the other based on a vector autoregressive (VAR)
model. While the former allows evaluating the impact
of a particular macroeconomic variable on the banking
system’s NPA and capital ratios, the latter reflects the
impact of the overall economic stress situation on the
NPA ratio and bank capital through a feed-back effect.
The macro stress tests are also conducted on a quarterly
basis.
3.10.2 The Committee notices that though micro level
(bank specific) stress testing guidelines have been
operative for quite some time, they are not being used
as supervisory tools to the desirable extent. In this
context, the Committee desired that stress testing
should be an integral part of the supervisory processes
and used extensively for deciding on the supervisory
stance. The Committee also recognized wide variations
in the way the banks conduct stress tests for their
portfolio and acknowledges that the assumptions and
severity of scenarios considered by the banks in this
regard have major repercussion on the management
actions that would be necessary in the wake of these
stress tests.
Since each bank has a different portfolio of risk
on account of varying business activities that it
undertakes, there is bound to be a fair degree of variety
in the stress scenarios that they consider. In this
context, the Committee is of the view that in order to
bring in an element of uniformity, consistency and
comparability in the stress tests across the banking
sector, supervisory estimates of few common scenarios/
macroeconomic environment variables based on
domestic/global financial market developments, eg.
GDP Growth, Sectoral Growth, Fiscal Situation,
inflation, External Sector, Capital Flows etc. as well as
interest rate movements, may be communicated to the
banks in advance for conducting the stress testing of
their individual portfolios. Further, the banks should
also be advised to internally upgrade their stress testing
framework (including back-testing) using plausible
stress scenarios in light of their portfolio and risk
appetite so that meaningful management actions are
possible.
Reverse Stress Test
3.10.3 Stress tests, when combined with carefully
constructed scenario analyses, can be helpful, but even
under the best of circumstances, stress tests have
limitations in anticipating potential events that would
result in bank failure. To overcome such limitations,
the method of “reverse stress tests” compliments stress
testing.
3.10.4 Reverse stress tests, starts from a known stress
test outcome (like breaching of regulatory capital ratios,
illiquidity or insolvency) and anticipating events that
would lead to such an outcome for the bank ( Refer:
“Principles for sound stress testing practices and
supervision” by the Basel Committee on Banking
Supervision in May 2009, ). To have uniformity across
banks, the Committee recommends that reverse testing
could be carried using parameters like large operational
risk events, large litigations, large net redemptions,
credit rating downgrade, collapse of wholesale/retail
funding markets, loss equal to say 10-20% of Tier-1
capital (or may be CET-1) within 2-3 quarters etc. Also,
the reverse stress testing should be undertaken by the
banks with active involvement of Senior Management.
3.10.5 The Committee is of the opinion that for
smaller and simpler banks, reverse stress-testing may
be restricted as a qualitative exercise, involving scenario
selection by senior management. However, for large
and complex banks, a more sophisticated approach to
reverse stress-testing involving quantitative modeling
may be developed by the bank.
3.11 Thematic Review
3.11.1 Thematic supervision is a way of risk-based
supervision, where thematic methods are applied to
perform risk identification, detection, assessment and
management that occur at several banks and have a
material impact on banking sector. In combination with
other information, the repeated, frequent and similar
problems indicate areas where thematic reviews are
needed. Thematic review may be conducted in any area
where inherent risk may be perceived to have potential
for contagion. Such areas may include, for example,
Liquidity risk management, Asset quality, trade
financing activities, mortgage lending, treasury
activities, Risk disclosures (Pillar 3), management of
money laundering risks, KYC compliance, etc. Under
RBS regime the areas for conduct of thematic study
would be guided by the process of risk identification.
Risks to be identified for thematic study may come from
several different sources, including the following:
-
Supervisory findings of individual banks;
-
Nature and trend of customer complaints;
-
Trends observed from Consumer protection
angle which may include new products
being offered, feedback from consumer
protection organizations etc
-
Market data and market intelligence;
-
Emerging trends from macroeconomic and
banking sector analysis;
-
Information gathered from meetings with
banks management especially with those
having below average rating;
-
Information received from law enforcement
agencies, peer international and domestic
supervisors; etc.
3.11.2 Thematic approach to supervision is not
intended to assess and handle risk at individual banks.
However, if prominent risks and problems are noticed
during thematic inspection at one or more banks, such
risks would have to be considered under bank specific
procedure which may lead to targeted inspection at the
bank.
3.11.3 The thematic work should be planned in a way
that would harmonize the work with bank specific
supervision. Also, the sample of banks to be considered
for thematic review should have a fair distribution
across banks with high risk to identified thematic risk.
Thematic Review can be carried out either through a
short on-site inspection, data request through
templates, theme discussions with banks etc. Thematic
reviews are consistent with the risk based supervisory
framework as such reviews help the supervisors in
being proactive in assessing specific issues across the
banking sector thereby ensuring optimum utilization
of available supervisory resources and revisions to
regulatory prescriptions, where necessary. The
Committee, therefore, recommends that thematic
review may be integrated into the proposed risk based
supervisory framework for enhancing efficiency and
effectiveness of supervision of commercial banks in
India.
3.12 Role of Auditors
Role of Internal and External Audit
3.12.1 Banks select their statutory auditors based on
the criteria approved by the Sub-Committee (Audit) of
the BFS which defines the appropriateness and
suitability for the selection and appointment of
statutory auditors, both for auditing of the whole bank
as well as for the branch auditing. As per the extant
guidelines, statutory auditors are not permitted to do
any other internal auditing work simultaneously for
the same bank. In addition to their normal functions,
as of now, the statutory auditors are required to furnish
certificates /validations for certain items, like verification
of SLR requirements, asset classification, income
recognition, provisioning, treasury functioning etc. The
statutory auditors furnish their findings / concerns in
the Long Form Audit Report (LFAR) to the bank and a
copy of which is forwarded to RBI by the bank. RBI had
initiated risk based audit regime for commercial banks
and the Risk Based Internal Audit (RBIA) framework
guidelines issued by DBS, RBI in 2002 mandating
selective transaction testing along with an evaluation
of the risk management systems and control procedures
prevailing in various areas of a bank’s operations.
However, most of the banks are yet to fully implement
the RBIA framework.
Views of the Committee
3.12.2 Effective audit function in banks should ensure
compliance with regulatory and prudential guidelines
by the concerned banks. The Committee has noted that,
the AFI of banks continue to throw up significant
divergences in classification of assets, shortfall in
provisioning, instances of delayed detection and
reporting of frauds etc. Such recurring divergences
highlight general inefficiency and inadequacy of the
audit function (both internal and external auditing) at
banks. With banks migrating to core banking platform
and even centralized risk management, audit of the
branches of banks has become mostly redundant.
Besides, the scope of branch audits hardly covers
aspects of Credit Risk Management and internal control
as part of operational risk.
3.12.3 As the efficacy of Risk Based Supervision would
be largely dependent on the accuracy and integrity of
the audited data /information provided by the banks
as part of off-site supervision, banks’ auditors would
need to play a crucial and effective role. The recent
consultative paper on “internal audit function in the
banks” put up for comments by the Basel Committee
on Banking Supervision states the function of Internal
Audit in the banks as:
“An effective internal audit function should
evaluate, independently and objectively, the
quality and effectiveness of a bank’s internal
control, risk management and governance
processes, which would assist senior
management and the Board of Directors in
protecting their organisation and its reputation.”
Further, the paper states that the Supervisors
should have regular communication with the
bank’s internal auditors to discuss (i) the risk
areas identified by both parties, (ii) understand
the risk mitigation measures taken by the bank,
and (iii) monitor the bank’s response to
weaknesses identified.
3.12.4 Bank supervisor and external auditors perform
different economic and statutory roles, and are
responsible to different parties – supervisors to their
governments and taxpayers, and auditors to bank
shareholders. However, their focus areas and concerns
show a remarkable degree of commonality. The Basel
Committee on Banking Supervision has recognised this
commonality in the Core Principles for Effective
Banking Supervision and stated that supervisors may
use external auditors to supplement the work of the
Supervisor. In this context, the Committee is in
agreement that the role of external auditors needs to
be enhanced. Also, bilateral meetings between the
supervisors and external auditors on specific issues of
supervisory concerns can yield fruitful results. Such
bilateral meetings should identify the exclusive areas
to be allocated to the auditors and the modalities for
ensuring accountability for the supervisor’s complete
dependence on the auditors. Indicatively, such areas
can include transaction testing, asset classification and
income recognition as per the prudential norms, etc.
3.13 Pre-requisites at banks for roll out of Risk Based
Supervision
3.13.1 The Committee considered it absolutely
essential that a minimum baseline risk management
framework should be in place at banks before RBS can
be rolled out. To this end, the Committee recommends
that RBI should ensure that an effective baseline risk
management framework is in place at the banks.
Alongside adherence to the risk management guidelines
in place for the banks, they should also have systems
in place to ensure the following:
-
Robust Management Information System
– This can be ensured if the bank has a
robust IT system that supports reliable and
quality data for effective decision making.
This may include implementation of
Enterprise Data Warehouse Project (EDWP)
at banks and provisions for improving data
availability /quality to RBI by way of
automated data flow from the bank;
-
Integrity of data submitted by banks to the
supervisory authorities;
-
Efficiency/transparency in internal transfer
pricing mechanism; and
-
Risk-return trade off and transparency in
pricing of loans and other products,
especially of Annual Equivalent Rates
(AER) and Annual Percentage Rates (APR)
of return on both sides of the balance
sheet; and
Indicatively, the risk management framework at the
banks should have the following elements:
-
Independence of Risk Management
Structure and Board level oversight on RMS
and Internal Audit function,
-
Risk Management system should be an
integral part of business processes,
-
Risk Based Internal Audit function should
be effective,
-
Strong ICAAP processes for determination
of Pillar II risks.
The Committee recommends that RBS should be rolled
out at the earliest instead of being rolled out in a phased
manner preferably from the next supervisory cycle
(2013).
CHAPTER 4
SUPERVISORY RATING
Introduction
4.1 Bank supervisors have legal powers to collect
extensive off-site information about bank’s financial
health, business plan and strategies etc. which are
normally not available to other stakeholders.
Additionally, onsite inspections are also undertaken by
the supervisors to verify the accuracy of off-site data
and observe the business processes, governance
systems & control from close quarters for gathering
further supervisory information. The information
gathered by the supervisor is used to identify current
and potential problems that the bank faces/may face,
for appropriate supervisory attention and effective
resource allocation. Generally, supervisors in most
jurisdictions use the information gathered by them
through various sources to arrive at a composite
measure of overall health of the bank. This composite
score is often termed as ‘Supervisory Rating’ and is
exclusively used for supervisory purposes including
intervention. The ‘CAMEL’ system of supervisory rating
is one such internationally recognized and popular
supervisory rating system which is in vogue in many
jurisdictions including India.
CAMELS Rating Framework
4.2 CAMEL model of rating was first developed in
the 1970s by the three federal banking supervisors of
the U.S (the Federal Reserve, the FDIC and the OCC) as
part of the regulators’ “Uniform Financial Institutions
Rating System”, to provide a convenient summary of
bank condition at the time of its on-site examination.
The banks were judged on five different components
under the acronym C-A-M-E-L: Capital adequacy, Asset
quality, Management, Earnings and Liquidity. The
banks received a score of ‘1’ through ‘5’ for each
component of CAMEL and a final CAMEL rating
representing the composite total of the component
CAMEL scores as a measure of the bank’s overall
condition. The system of CAMEL was revised in 1996,
when agencies added an additional parameter ‘S’ for
assessing “sensitivity to market risk”, thus making it
‘CAMELS’ that is in vogue today.
Approach for Supervisory Rating in India
4.3 Prior to 1998, the department of supervision
(DoS) had been rating the banks in India on the basis of
assessed ‘solvency’ relative to the impairment of the
components of reported owned funds. The Padmanabhan
Committee (1996) had observed that this form of rating
was inadequate since it did not evaluate the banks based
on financials such as capital adequacy, liquidity and
earnings and was misleading because even if the bank
was solvent, it might have had serious management,
operational and compliance problems which did not get
adequately reflected. The Committee had, thus,
recommended a need for substituting the rating with a
realistic rating framework modelled on the rating
methodology employed by the supervisory authorities
of USA. The Committee had also recommended two
separate models for Indian and foreign based banks
based on a differential mix of rating factors: CAMELS
(Capital Adequacy, Asset Quality, Management,
Earnings, Liquidity, Systems & Control) for Indian banks
and CACS (Capital adequacy, Asset quality, Compliance,
and Systems & control) for foreign based banks in India.
Each of the components in either CAMELS or CACS was
to be assigned a rating on a scale of 1-5 in order of
performance. A composite rating on a scale of A-E was
to be assigned as a summary rating. The Committee had
also recommended that unlike the US system where the
banks are rated after the on-site examination process,
the supervisory rating in RBI should be done at the
Central Office taking into consideration the findings of
the on-site examination process and also other
supervisory information available at Central Office. The
Committee was of the opinion that such an exercise
would be more realistic and comprehensive as it would
not be limited solely to the findings of the on-site
examination process.
4.4 Based on the recommendations of the
Padmanbhan Committee, the commercial banks
incorporated in India are presently rated on the
‘CAMELS’ model (Capital adequacy, Asset quality,
Management, Earnings, Liquidity, and Systems &
control), while foreign banks’ branches operating in
India are rated under the ‘CALCS’ model (Capital
adequacy, Asset quality, Liquidity, Compliance, and
Systems & control). As mentioned above, the Committee
had originally recommended a CACS model, which was
subsequently modified to also include Liquidity (L) as
an additional parameter. Further modifications, in the
form comprising additional granularities in the rating
scale of parameters under CAMELS have since been
introduced by RBI. Presently, each of the components
of CAMELS is rated on a scale of 1-100 in ascending order
of performance. The score of each CAMELS element is
arrived by aggregating (by assigning proportionate
weights) the scores of various sub-parameters that
constitute the individual CAMELS parameter. Each
parameter is awarded a rating A-D (A-Good, B –
Satisfactory, C -unsatisfactory, and D-poor). Further, to
bring granularity in rating, there are modifiers by way
of (+) and (-) under each of A, B and C making a total of
ten scales A+ through to D. The composite “CAMELS
rating” is arrived by aggregating each of the component
weights as indicated in the table below. Further the
overall composite score is adjusted downwards for poor
performance in one or more components.
Weights of various parameters under the CAMELS/CALCS Model |
|
CAMELS |
CALCS |
Capital Adequacy |
18 |
18 |
Asset Quality |
18 |
18 |
Management |
18 |
– |
Earnings |
10 |
– |
Liquidity |
18 |
18 |
Compliance |
– |
26 |
System & Control |
18 |
20 |
Principles of Supervisory Rating
4.5 Bank Supervisory ratings are supervisory
opinions about the ‘soundness’ of a bank. Soundness
may be commonly understood in terms of risk of bank
failure. The supervisory ratings reflect both quantitative
assessment of risks to bank failure and expert
supervisory judgment on relative and absolute strength
of the bank. Thus, rating cannot unequivocally be
explained by a particular set of data and criteria. From
a supervisory standpoint, depositor protection is the
primary objective of bank supervision and a bank failure
may be construed as a situation wherein the concerned
bank becomes/ is likely to become insolvent and is/would
be unable to repay its depositors. The capital buffer
maintained by the bank for absorbing unexpected losses
is the single largest determinant of the solvency of a
bank. The unexpected losses in a bank could arise due
to crystallisation of single or multiple risks which the
bank faces in its business. Normally banks also have
access to additional capital from various sources,
including shareholders and lenders, which would
cushion the impact of capital erosion in stress scenarios.
Since banks’ retained earnings along with ability to
raise fresh capital is key to building up a buffer for
absorbing unexpected loss, supervisors generally
perceive such banks to be comparatively more sound.
It must be emphasised that while the failure of a bank
is primarily dependent on the financial strength of that
bank, potential support available to the bank during
distress by other shareholders and national authorities/
Central Bank in the form of capital injections, asset
purchase, liquidity provisions etc. due to a bank’s
systemic importance bring additional dimension in
assessing bank failure by the supervisor. In this context,
it may also be noted that the earnings of a bank could,
however, be quite volatile partly on account of their
higher leverage which is also reflected in consistently
higher volatility in returns on banking stocks over the
non-financial stocks over past several decades.
Statistical model for predicting deterioration of
banks’ financial conditions (leading to failure of the
bank) involves searching of explanatory variables that
provide a reliable forecast for the financial failure.
Academicians have tried to develop models to predict
possible financial failures in different industries.
Altman (1968) applied the discriminant analysis to
corporate failures using financial ratios calculated from
balance sheet and income statement data. Logistic
regression and Probit models have been widely used
in the prediction of bank failure (Martin, 1977;
Thomson, 1991, Espahdobi, 1991). These methods are
preferable to discriminant analysis because of superior
statistical properties and have found acceptance with
a growing number of researchers. Financial ratios
measuring liquidity, solvency, asset quality and
earnings are the main explanatory variables used to
estimate the probability of failure of the bank. However,
due to the development of risk analysis, the causes of
bank failure can now be more closely identified as
arising from such risk as credit risk, market risk,
operational risk, liquidity risk, interest rate risk etc.
Deliberations in the HLSC
4.6 The changing nature of banking evident in a
shift from offering traditional products and services to
engaging in more complex banking activities has
necessitated that the supervisor periodically refines the
contours and methods employed for an accurate and
reliable estimate of banks’ health. In this context, the
Committee has expressed its preference for a risk-based
approach to supervision of commercial banks, wherein
the supervisory focus would be on the major risk drivers
in the bank. Against this backdrop, the Committee
deliberated upon whether a modified form of CAMELS
rating with enhanced risk focus could be adopted for
India under the RBS regime. It observed that the
supervisory authorities in Hong Kong and Spain had
successfully adopted a CAMELS based rating system
even though their supervision was conducted under the
risk based approach.
4.7 The Committee had elaborate deliberations on
the existing rating framework under the CAMELS
pattern. To supplement the work of the HLSC, a
Technical Committee (TC) was constituted to study the
supervisory rating framework in detail and make
recommendations for consideration of the HLSC.
4.8 The Committee observes that while the rating
system had served the needs of the supervisors to a
reasonable extant, it needed to be revamped in the light
of some limitations observed in the supervisory journey
of RBI and also apprehensions and reservations
expressed by commercial banks. Some of the notable
limitations of the CAMELS framework observed by the
Committee include the following:
-
The rating system was largely focused on
a “point in time” assessment of the
performance of the bank while the risk
elements were not receiving adequate
focus. The rating was, therefore, neither
forward looking nor dynamic in nature.
Also various risk mitigants as part of
System and Control were not being
adequately factored.
-
There was considerable subjectivity in
analysing parameters like Management
and Systems & Control as part of the
CAMELS based rating framework due to
which there was lack of consistency both
within and across the banks.
-
The rating was primarily based on the
comprehensive on-site assessment of the
bank as part of the AFI and was not
adequately leveraging upon inputs from
off-site surveillance of banks including
other monitoring tools like ICAAP, RPTs,
internal and external audits of the banks.
-
The rating scale was too granular (10 point
scale) and therefore, it was difficult for RBI
to assign appropriate supervisory
responses commensurate with each rating.
-
Banks having been mandated to maintain
minimum capital as per licensing and
prudential norms, were receiving a better
rating due to high weightage given to level
of their capital adequacy. (Most banks were
maintaining adequate regulatory capital
and thus obtaining higher scores on this
count). Earning of the bank was also being
accorded higher marks in CAMELS even
though higher earnings could be both a
source of strength (due to retained
earnings) and also a source of risk (higher
earnings due to risky activities).
4.9 While deliberating on the adequacy of the
present CAMELS rating framework, the committee
observed that more often than not the rating score
assigned to a bank, did not accurately reflect the
supervisory assessments. Some of the limitations of the
rating framework which lead to erroneous supervisory
assessment have already been highlighted above. The
Committee is concerned that the process of arriving at
a composite rating by considering various parameters
and assigning appropriate weights to various parameters
is a very complicated exercise and requires a lot of fine
tuning based on supervisory experience and judgement.
Views of the Committee: Shift in focus
4.10 For a new supervisory rating system under the
proposed risk based approach to supervision, the
Committee decides to focus only on the risk elements
and delink the exercise from performance evaluation.
In this context, it is also agreed that the major risk
elements (including pillar 2) would be identified and
their net risk would be derived by adequately adjusting
the respective risk mitigants against the inherent risk.
Further, the foreseeable risks which result in expected
loss could be covered by the bank in their pricing and
therefore, the focus of the risk assessment exercise
should predominantly be on those risks which could
translate into unexpected losses.
4.11 The Committee is also concerned that although
the existing CAMELS based rating framework captured
a few risk elements, it was primarily geared towards
assessing the banks’ performance. It is of the view that
the purpose of supervisory rating should be to reflect
the risks which may cause a bank to fail rather than
representing banks’ performance alone. The Committee
concludes that the CAMELS based rating system would
not be appropriate under the risk based approach that
is being contemplated in the Indian context and,
therefore, is of the view that the existing supervisory
rating framework needed to be realigned in a manner
so as to capture the ‘riskiness’ of the bank.
4.12 The Committee is of the view that the risk of
bank failure should ideally be captured using the
parameters which are sources of risks in the bank. Some
of the key risk areas which have already been identified
and internationally accepted are credit, market,
operational, liquidity, strategic/business, group risk etc.
While a quantitative measure of key risks like Credit,
Market and Operational risk are possible and enumerated
under pillar I of Basel II Framework, there are limitations
in quantitative measurement of other key risks which
must be assessed qualitatively. Thus, while all the risks
which a bank is exposed to are captured under pillar 1
or pillar 2 the exact measurement and their quantification,
is an arduous task considering the need for qualitative
interpretation. Also, a lack of clear understanding of the
correlations (if any) between various risk areas and a
very limited availability of past data on bank failures
makes it extremely difficult to objectively and accurately
assess the probability of failure of a bank. Supervisors
have been cognizant of these limitations and tried to
indirectly measure and assess some of the nonquantifiable
risks through expert supervisory judgement.
4.13 The committee notes that supervisory judgement
is not an exact science. While a lot of researches have
gone into the methods of quantification of various risks,
these are invariably based on a few basic supervisory
assumptions. Additionally, the Pillar 2 risks and the
control elements like Management, Systems and
Control, strategy etc. can only be assessed qualitatively.
Also, the nature of the banking industry and local
environment can be factored into assessment of banks
only in a qualitative way. The Committee is aware of
these limitations and is of the opinion that elements
which predominantly require a qualitative assessment
should be judged taking into account the prevailing
industry practices and should be rated on a relative
benchmark vis a vis the practices followed in other
banks.
Proposed Supervisory Risk Rating
4.14 Explanatory parameters contributing to risk can
either be measured statistically or by expert judgement.
Due to the range of information and their diversity,
many explanatory parameters can only be estimated
through qualitative expert judgement, however,
wherever possible, such expert judgement should be
based on statistical estimates and other quantitative
indicators.
4.15 To measure various risks in a bank, the
Committee recommends adopting a Scorecard approach
wherein respective explanatory parameter would be
assessed by adding up a set of component scores of key
factors. In devising a scorecard based supervisory
model, it is important that factors and respective
weights to be assigned are determined using statistical
tools and also supervisory judgment. In the context of
application of weights to risk rating, it is pertinent to
note the observations made under the CEBS guidelines
on SREP under Pillar 2:
-
Higher risk to get a higher weight than smaller
risks
-
A risk should get a higher weight than its
control
-
Weaker controls should get higher weight than
stronger ones
4.16 Based on the recommendation of the Technical
Committee, the HLSC has identified five Inherent risk
groups to be considered for determining the risk of
unexpected losses that may crystallise in any bank:
4.17 The net risk arising from each of the respective
risk groups is computed by netting/adjusting the
respective Risk control against the inherent risks. The
net risk in the bank may be represented by the
following equation:
where,
Risk Net = Net Risk is the residual risk remaining
after taking into account the mitigating effect of Risk
Control measures for the corresponding risk group.
This is also a measure of the probability of unexpected
losses materializing in a bank
Risk Inherent = Measure of uncertainty in business
operations of the bank which has the potential to
translate into unexpected loss.
Risk Control = Measure of system and Control put
in place for mitigating the Inherent risk for respective
risk group component. Governance and Oversight by
the management which are high level controls and
cannot be attributed to any single identified risk groups
and are sought to be captured using a separate template
(Governance and Oversight). A lower Risk Control score
corresponds to a better control and governance
framework for the respective risk groups.
4.18 For the purpose, a list of factors considered for
determining Inherent Risk and efficacy of Risk Control
elements (using templates- indicative templates for few
risk groups are enclosed as Annex) for the respective
risk groups that could be used in the scorecard after
applying suitable weights (The factors and weights
would have to be calibrated by back testing and
statistical analysis) have been identified as under:
Probability of failure of bank
4.19 While the overriding objective of the supervisors
is to ensure that the bank is financially solvent, under
the risk-based approach to supervision, it is imperative
that the supervisor has some measure of the absolute/
relative probability of failure of bank in order to be able
to exercise differentiated supervision. While it is
theoretically possible to model and estimate the
probability of failure of banks using statistical method
like Logistic regression model, in practice, it is
impossible to achieve an exact estimation of default
probability as the default event, in the form of bank
failure suffers from lack of adequate historical data.
Actual defaults of banks in the Indian context are
extremely rare and poor financials have generally
served as indicators to determine if the banks are
financially viable or not. The supervisory actions like
forced mergers /amalgamation have more often than
not precluded the possible failure of banks in India.
Since the supervisor is more interested in
identifying problem banks rather than in accurately
measuring the exact default probability, it would suffice
if the supervisor using a reasonable model is able to
obtain a rough estimate of likelihood of the bank
failure. Supervisor should be able to identify key
explanatory parameters that are responsible for bank
failure and the approximate weights that need to be
assigned to these in the scorecard based model. The
supervisor should also be able to construct a relative
scale of default probability to be able to judge and rank
the banks on the relative scale. In this context, it must
be emphasised that the supervisory rating assigned to
banks is essentially a measure of relative probability of
failure in comparison to other banks.
4.20 The Committee is of the opinion that the key
elements of the supervisory action/intervention should
be based on the outcome of the risk assessment and
supervisory rating exercise. The objective of the
supervisory action/intervention would be to reduce the
probability of failure of bank to a tolerance level as
determined on the basis of supervisory comfort. In this
context, it is important that under the Risk Based
Approach to Supervision, the supervisor sets its risk
tolerance level and also sets the supervisory benchmarks
for net risk in banks, supervisory Capital (over and
above the minimum regulatory capital) and also an
acceptable level for probability of bank failure.
Role of Capital/ Capital Support (Available Capital)
4.21 Capital Support is the buffer available with the
bank to absorb unexpected losses that may materialize
in the banking books. All banks in India are required
to maintain a minimum level of regulatory capital,
However the supervisor, in his assessment under Pillar
2 of SREP may determine the adequacy/inadequacy of
the capital held by the bank vis-à-vis the risks inherent
in its business and could require the bank to hold
additional capital if he determines that the risk to
unexpected losses cannot be adequately covered by the
available capital. Since all the risk in the bank including
the Pillar 2 Risk are to be assessed using a scorecard
approach, the consequent supervisory rating exercise
should be able to assess the adequacy/inadequacy of
the available capital and also compute additional capital
(supervisory capital), if required. Thus, the Committee
recommends that determination of adequacy of
available capital as part of the SREP exercise could be
integrated with the supervisory rating and the
requirement of additional capital, if any, could be on
the basis of the supervisory rating of the bank.
Supervisory Rating (indicating the probability of
failure)
4.22 The risk to failure of a bank can be ascertained
by adjusting the net Risk of the bank against its
available capital. Though, the capital support may also
be inferred in terms of available capital, sustainability
of earnings and past ability to raise capital as
explanatory variables, in times of distress, there is a
possibility that the bank would neither be having any
retained earning not be able to generate enough
earnings nor would it be in a position to raise additional
capital from shareholders. Further, the banks build up
their capital either through retained earnings or equity
capital infusion from the shareholders which are
reflected in the quality/quantity of the available capital.
Under these circumstances, the capital available may
be considered as sole buffer available to the bank.
Accordingly, the Capital Adequacy Ratio of the bank
(CRAR) is to be used as a measure of the capital
available(Capital Available) and is measured on a
descending linear scale (from 4 to 0) with the bank
having available capital beyond a supervisor determined
level of CRAR assigned a score of 0.
The interplay between the Risk Net and Capital Available for ascertaining a measure of risk of bank failure
is not well established. However, based on an empirical
analysis, the relationship can be approximated by the
following equation:
The values of β0 and β1 1are – 5.832 and 3.339
respectively. The relative probabilities of failure would
need to be rescaled to estimate actual default probability
based on actual observations/instances of bank failure/
financial distress.
Supervisory Intervention /Monitorable action plan
4.23 The purpose of the supervisory rating exercise
would be to apprise the bank about the key risk areas
identified by the supervisor amongst various risk
groups including their respective inherent and control
parameters plus the direction/trend of the risk in each
group and also overall risk. From the supervisory
perspective of reducing risk in key risk groups and also
bringing down the probability of failure (if falling
outside the comfort level of the supervisor) of bank,
the supervisor would seek to bring down the risk of
failure (Risk Failure) by suggesting measures aimed at
either addressing specific parameters under identified
risk groups (Risk Control and/ or Risk Inherent) or/and
mandating holding of additional supervisory capital.
Graphically, this can be depicted as follows (Fig. 2):
In this context, the Committee proposes to use
a matrix approach (Box 4) for determining the nature
of supervisory action as under:
Based on the supervisory rating, a comprehensive
supervisory intervention plan for the bank would be
prepared. It is important to ensure that the proposed
supervisory action plan for the bank is adequate and
appropriate to its assessed risks across all risk groups
and would be able to address the assessed deficiencies
/concerns in a demonstrable manner. The Committee
is of the view that the supervisory intervention should
be shared /discussed with the bank’s senior management.
4.24 Supervisory Ratings
Indicatively supervisory rating of the bank
determined in terms of its relative and approximate
probability of failure vis-a-vis its risk of failure can be
represented as under Fig 3 & 4 respectively:
Good (A): Probability of failure is well below the
supervisory risk appetite. The banks which are rated
as good are perceived to be healthy and would require
very limited supervisory intervention.
Satisfactory (B): Probability of failure is within the
acceptable supervisory risk appetite. These banks have
a few risks which are of concern that could possibly be
addressed by improving the risk controls. In such banks,
the management, Board of directors and external
auditor would be apprised by the supervisor about the
potential risks that the bank faces and the specific
actions required to correct these deficiencies.
Unsatisfactory (C): The bank would have a probability
of failure marginally higher than the supervisory
comfort. Along with improving /tightening risk
management and controls, the banks would also need
additional capital to bring down the probability of
failure within the supervisory comfort zone. The risk
mitigation plan prepared by the supervisory team
would need to be closely monitored for compliance by
the bank.
Poor (D): The bank has a high probability of failure and
would need to not only raise additional capital but also
restructure its business to bring down the inherent
risks in the business. The banks with a ‘D’ rating would
be placed under the PCA framework and their
compliance with the mandated supervisory action plan
would need to be monitored on a monthly basis. The
intervention could be in the form of instructions /
directions to the management and the board of
directors to consider options such as restructuring the
bank or seeking a prospective partner for merger,
amalgamation or takeover. The risk mitigation plans in
such banks would need to be continuously monitored
for compliance.
Very Poor (E): The bank with this rating is no longer a
viable entity and would need to be wound up or
merged/amalgamated with another bank. The
supervisory action would entail taking over management
control of the bank and also finding a suitable merger
proposal or putting the bank under an orderly
resolution process.
Disclosure of Rating
4.25 All supervisory information including the
supervisory rating is highly confidential. A bank’s
supervisory rating is to be known only to the bank’s
senior management and the concerned supervisory
officials. While the supervisory rating is confidential
and not disclosed to public even on a lagged basis, the
public may infer the nature of supervisory information
on bank’s health based on subsequent actions or
disclosures by banks.
4.26 Deliberating on the need to publicly disclose
the findings of the rating exercise, the members are
unanimous that such information about banks with
poor rating would have a direct bearing on the public
perception and could lead to a run on them. The
Committee observed that in line with its depositor
protection objective, if the supervisor is convinced that
the bank is not capable of meeting its depositor liability,
he would place the bank under moratorium which
would anyway be public information. In view of the
above, the Committee is of a considered opinion that
supervisory rating should not be made public. This
recommendation is in line with the extant international
supervisory practices.
CHAPTER 5
CONSOLIDATED & CROSS-BORDER SUPERVISION
5.1 Introduction
5.1.1 In India, banks can undertake certain eligible
financial services or para-banking activities either
departmentally or by setting up subsidiaries. Under the
provisions of Section 19(1) of the Banking Regulation
Act, 1949, banks may, with the prior approval of RBI
form subsidiary companies for undertaking various
types of banking business which they are otherwise
permitted to undertake2, for carrying on the business
of banking exclusively outside India and for such other
business purposes as may be approved by the Central
Government. During the last two decades, a host of
non-banking activities like Mutual Fund, Insurance,
Pension Fund, Housing Finance, Depositories, Merchant
Banking, Primary Dealer, Payment Services etc. are
being undertaken by banks in India. While some of
these activities can be undertaken departmentally by
the bank, the extant regulations necessitate floating of
separate subsidiaries by banks to undertake Insurance,
Securities and Pension Fund activities.
5.1.2 While the group entities are generally a source
of strength since they enable diversification of revenue
and income streams they may also prove to be a source
of weakness adversely affecting the financial condition,
reputation and overall safety and soundness of the
bank as witnessed during the recent financial crisis.
One of the lessons for supervisors globally has been
on laying renewed focus on Consolidated Supervision
of bank groups. The consultative document of Core
Principles, BCBS3 has significantly enhanced the role
of supervisors for effective supervision of the banking
group on a consolidated basis. The group-wide approach
to supervision of “banking group” has been expanded
to include non-bank (including non-financial) entities,
if relevant, along with holding company, bank and its
offices, subsidiaries, affiliates and joint ventures, both
domestic and foreign.
Present Approach to Consolidated Supervision
5.1.3 Consolidated Supervision is defined as “an
overall evaluation (qualitative as well as quantitative)
of the strength of a group to which the bank belongs.”
The supervisor’s purpose in consolidated supervision
is not to supervise all the companies in a group
containing a bank but to supervise the bank (or
supervised institution) as part of the group and assess
the potential impact of other group companies on the
bank. Thus, it is a group-wide approach to supervision
where all the risks run by a banking group are taken
into account. The approach to consolidated supervision
has two components: Quantitative and Qualitative.
5.2 Consolidated Supervision in India
5.2.1 Based on the recommendations of the Multidisciplinary
Working Group4, the Consolidated
Supervision framework has been in place in India with
three key components:
-
Consolidated Financial Statements (CFS):
All banks coming under the purview of<
Consolidated Supervision of RBI are
required to prepare and disclose Consolidated Financial Statements in
addition to solo financial statements.
-
Consolidated Prudential Reports (CPR) for
supervisory assessment of risks which
may be transmitted to banks (or other
supervised entities) by other group
members and
-
Prudential limits relating to capital
adequacy, large exposures/risk
concentration and liquidity risk
management on a consolidated bank basis.
Quantitative Supervision
5.2.2 Consolidated Reporting: As per the RBI
guidelines, Consolidated Financial Statements is
required to be prepared in terms of Accounting
Standard (AS) 21 and other related Accounting
Standards prescribed by the Institute of Chartered
Accountants of India (ICAI). The CFS normally includes
consolidated balance sheet, consolidated statement of
profit and loss, Principal Accounting Policies, Notes on
Accounts, etc. and is publicly disclosed. The Consolidated
Prudential Reports (CPR) comprise of Consolidated
Balance Sheet, Consolidated Profit & Loss Account, and
select data on financial/ risk profile of the consolidated
bank. For the purpose of preparation of CPR, the
consolidation excludes group companies which are
engaged in: (a) insurance business and (b) businesses
not pertaining to financial services. The bank also
discloses maturity wise distribution/ analysis of assets
and liabilities on a consolidated basis in the CPR.
Additionally, certain prudential limits on Capital
Adequacy, large exposures and liquidity are also
prescribed.
Qualitative Supervision
5.2.3 In addition to the above quantitative norms, as
part of RBI’s guidelines to the banks on para-banking
activities, certain qualitative norms have also been
mandated for the parent bank. These include evolving
appropriate strategies on:
- Maintaining an 'arms length' relationship
with the subsidiary /mutual fund
sponsored by the bank in regard to
business parameters
- Periodic review of the working of
subsidiaries by the Board of Directors of
the parent/sponsor bank and
- Periodic inspection/audit of the books
and accounts of the subsidiaries
Supervision of Large and Complex Banks
5.2.4 The Consolidated Supervision framework for
bank groups in India at present can be broadly classified
into two categories:
-
The framework for all banks having
subsidiaries;
-
The framework for select Large and
Complex Banks (LCB) which are
systemically important.
While the quantitative supervision framework
is applicable to all the banking groups (both i and ii)
some of the qualitative aspects of supervision have
been specifically mandated for only (ii). Incidentally,
some of these LCB are also classified as Financial
Conglomerates (FC). Further, based on criterion of size,
interconnectedness, substitutability and extant of
overseas operation and also owing to their importance
from the perspective of systemic stability, some banks
have been identified for close and continuous
monitoring. The offsite and onsite supervision of these
banks is conducted at the the central office level of the
Department of Banking Supervision.
Supplementary Qualitative supervision for LCB/FC
5.2.5 In addition to CPR, the banks considered as
large and complex are also mandated to submit a
quarterly offsite Return. The Return, presently received
outside the OSMOS system is designed to identify and
track the following aspects within a banking group:
-
Large intra-group transactions and risk
concentrations in major financial markets
-
Adherence to arms length principles
-
Build-up of any disproportionate intragroup
exposure (both fund based as well
as non- fund based) amongst group entities
-
Group-level concentration of exposure to
various financial market segments and
counterparties outside the group
-
Group entities with deteriorating financials
and large risk concentrations and
-
Information on adverse events such as
fraud, penalty/ strictures etc levied/ passed
by regulators/ courts/ administrative
agencies etc.
5.3 Views of the Steering Committee
General
5.3.1 Over the last two decades, the banks have
increasingly looked to diversify their revenue streams
by venturing into non-banking activities exposing
themselves to new risks. Against this back drop, it is
imperative for RBI, as the lead supervisor of the banking
groups, to supervise such a bank not only as a solo
entity, but also on a consolidated basis. The Committee
has deliberated on the adequacy of the supervisory
approach to consolidated supervision of banks in India
and is of the view that though adequate regulations
and policy are in place, the process of consolidated
supervision needs enhanced focus. The committee is
of the view that the consolidated data and reports being
gathered as part of CPR needs to be effectively utilized
and recommends that along with the data for solo
banks, the consolidated data should be adequately used
for offsite analysis of banking groups.
5.3.2 The committee also notes that though many of
the banks have more than one subsidiary /associate,
their group structure is fairly simple. Further, many
banks have sponsored one or more Regional Rural Banks
(RRB) which are their only group entities. In this regard,
the Committee is of the view that for smaller bank
groups having limited intra-group transactions, wherein
the parent bank has either only RRBs as subsidiaries or
the combined assets of subsidiaries is less than 10% of
the groups consolidated assets, the Consolidated
Supervision may be limited to monitoring adherence
to quantitative regulatory norms and monitoring of
contagion or concentration risk. However for other
larger banking groups with significant non-banking
activities and important from systemic viewpoint, the
extant framework for Consolidated Supervision needs
to be strengthened. Thus, the Committee recommends
a differentiated approach to Consolidated Supervision
with more focused attention to large and complex
banking groups.
5.3.3 The Committee notes that as per the extant
guidelines the banks are required to prepare their
annual ICAAP documents on a group-wide basis. Thus,
the supervisor while conducting SREP exercise as part
of Pillar 2 Supervisory Review would be in a position
to assess the strength of the bank not only on a standalone,
but also on a group-wide basis. In conformity
with the overall objective of preparing the supervisory
framework for bank towards risk based supervision,
the Committee recommends having a risk focused<
approach to consolidated supervision. To begin with,
large and complex bank groups may be considered
under this approach.
5.3.4 As the lead supervisor of banking groups, in
addition to supervision of the parent bank on a solo
basis, RBI is also interested in prudential supervision
of the group as a whole. In this regard, the Committee
considers it appropriate that the RPT for the bank, in
addition to capturing the risks from the parent bank,
should also adequately capture the risks arising out of
non-banking entities in the group. Further, during the
supervisory assessment of the Group risks and
formulation of appropriate supervisory response as
part of consolidated supervision, impact analysis of
potential risk arising from the material entities of the
group should be conducted.
Specific views on:
Group Capital Adequacy
5.3.5 A key area of concern for the supervisors in
Consolidated Supervision is capital adequacy. A
regulatory inconsistency/difference could lead to
‘double gearing’, where the same capital, issued by the
parent, may be counted twice. Another consequence
could be in the form of ‘excessive leveraging’, whereby
the debt issued by the parent could be down-streamed
as equity to other subsidiaries. The supervisor should
be able to assess the minimum capital (prudential
capital) that a group should hold and also the eligible
capital that the supervisor would recognize for capital
adequacy purpose. Further, the banking group would
be expected to hold a surplus capital over the eligible
capital to ensure that the eligible capital does not fall
below the required capital. This capital should also be
able to cover the unexpected losses that may arise due
to risks which have not been factored for capital
adequacy purpose. The materiality of any group entity
may be determined by considering the significance on
group’s capital and financial position including the
potential risks for significant loss. Further, while
determining materiality of the entity, the above
principles may be subjected to the following quantitative
cut-off test:
The RRBs, however, need not be subjected to
this materiality test.
5.3.6 The group should prepare and have in place a
capital management plan with appropriate systems and
processes to identify, measure and manage risks arising
from activities of the group entities (including nonregulated)
under both normal and also stressed
conditions. Often the surplus capital available within
the group may not be freely transferable, due to extant
legal and regulatory norms. Thus, while assessing the
capital adequacy of the banking group the supervisor
would also need to assess the level of freely available
‘surplus’ capital.
Understanding Group structure and business
5.3.7 The structure of a banking group can be fairly
simple wherein the bank is the parent or very complex
wherein the bank is itself a part of another larger group.
While most of the domestic banks in India have a fairly
simple structure with the bank being the parent, some
of the banking groups have resorted to cross-holding
amongst group entities making their structure fairly
complex and opaque. The presence of step-down
subsidiaries, if any, further complicates the group
structure. A thorough understanding of the group’s
governance, operation and legal structure including the
business lines, risk management and control is, thus,
essential for any supervisor. While some information
may be publicly available the Committee is of the
opinion that the supervisor should develop clear
understanding of the group structure and share holding
pattern along with major lines of accountability within
the group.
Governance
5.3.8 A banking group is not a legal entity but a
business enterprise in which the legal entities operate
as a group under the parent bank to execute a business
strategy. The business model envisages certain common
and consolidated business initiatives through joint and/
or concerted resource mobilisation for the group and
for each legal entity within the group. The objectives
of establishing ‘fit and proper’ norms for groups is to
ensure that the supervisors are able to determine
whether the entities are soundly and prudently
managed and directed and whether key shareholders
are a source of weakness to those entities. Some key
parameters on which the supervisor may assess the
effectiveness of Governance include: (i) Competence
of senior management; (ii) Strategies and policies;
(iii) Internal control and audit including group wide
oversight; (iv) Internal risk management structure;
(v) Policy on Conflict of interest; (vi) Transparency and
Public Disclosures.
Group Risk Management
5.3.9 Theoretically, the benefits of conglomeration
include potential risk-reducing gains from geographic
and product diversification and gains from potential
cost synergies5. The group, by transferring risks from
one corporate entity to another in which that risk may
either be managed more efficiently or through
geographic and product diversification tries to achieve
risk-reducing gains. However, a poor group-wide risk
management structure could easily offset the gains of
risk-reducing through diversification. In this context,
group risk management plays a key role. While
assessing the group-wide risk, the supervisors should
primarily focus on the following:
-
Board and Management oversight of groupwide
risk management;
-
Risk identification and measurement
process;
-
Groups internal control mechanism and
effectiveness thereof; and
-
Integration of risk management with
management objectives.
Intra-group Transactions
5.3.10 Supervisory concerns may arise when intragroup
transactions and exposures (ITEs) have potential
for negatively impacting the parent bank. Another
source of concern is that ITEs provide avenues for
“contagion”, the danger of which increases when the
group uses multiple gearing and excessive leveraging.
The supervisor must, thus, assess the appropriateness
of the significant ITEs on the following parameters:
-
Capital or income being inappropriately
transferred from the bank;
-
Whether the ITEs are at arm’s length and
not disadvantageous to the bank;
-
Impact on solvency, the liquidity and the
profitability of individual entities within
a group;
-
Scope for supervisory arbitrage.
Liquidity Management
5.3.11 Banking groups could adopt a variety of
structures for managing liquidity risk that range from
highly centralised to highly decentralised. The decision
on an appropriate structure for liquidity management
could be based on considerations of efficiency,
minimisation of funding costs, diversification of
funding sources, technology systems in place for ALM
, feasibility of moving funds and collateral and also
taking into consideration regulatory and legal aspects
impacting cross-border /sectoral flows of funds.
5.3.12 The liquidity risks which a group entity may
be potentially exposed to, can be broadly categorized
under following three types: (i) Funding mismatch risk;
(ii) Market liquidity risk; (iii) Contingent liquidity risk.
For appropriate management of liquidity risk at a grouplevel,
the group should formulate a liquidity
management framework covering significant group
entities from liquidity perspective. In this context, it
would be desirable if a uniform approach towards
liquidity management principles across the entire group
is adopted. Also, material entities of the group from
liquidity perspective should conduct a stress test at
periodic intervals, factoring in the entities’ business
models and environmental risks. The results of such
liquidity stress test should be reviewed by an
appropriate committee at entity level and also reviewed
by the parent on an annual basis.
5.4 Cross - Sector Supervision (Domestic)
Legal Challenges in supervision of non-bank group
entities
5.4.1 A fundamental problem facing supervisors in
Consolidated Supervision is their limited rights in
accessing prudential information on those parts of the
group which they do not supervise. There is no legal
basis for undertaking a supervision /regulation of a
banking group. In essence this means that within a
banking group, the RBI cannot seek information from
the Insurance /Securities entities either directly or
through their sectoral supervisors (IRDA/SEBI) in the
event of undesirable developments in the group. This
limitation is more pronounced in Consolidated
Supervision of large banking groups which have
significant presence in non-banking activities wherein
the parent bank is exposed to risks arising out of
material group entities. The regulators have tried to
work around this handicap by instituting high level
forums for exchange of supervisory information. Some
form of group wide monitoring is also being undertaken
by calling for financial information about the subsidiary
through the parent bank. However, these arrangements
are only informal and do not have any legal sanctity.
In this context, the Working Group on Introduction of
Financial Holding Company (FHC) Structure in India
(Chairperson: Shyamala Gopinath, May, 2011) has
recommended FHC model under RBI’s regulation as a
preferred model for the financial sector in India. Since,
the success of Consolidated Supervision framework is
incumbent upon gathering/analysis of financial
information of the group entities, there is thus a need
to formalize the information sharing arrangements
between the RBI on one hand and the bank on the
other; and amongst the regulators. In this connection,
it may be mentioned that the proposed amendment to
the Section 29 of the BR Act, 1949, seeks to empower
RBI to gather information on the subsidiaries of the
banking companies.
Supervisory Co-operation & Information Sharing
Mechanism
5.4.2 As part of inter-regulatory cooperation, an
informal arrangement amongst the financial sectors
regulator existed in the form of a High Level Coordination
Committee on Financial Markets (HLCCFM). The
functions of the HLCCFM have since been subsumed
by a formal body of Financial Stability Development
Council (FSDC), with representatives of Government,
RBI, SEBI, IRDA and PFRDA as members. Along with
systemic stability and financial inclusion, monitoring
of large FCs is one of the mandates of FSDC. A broad
framework and modalities for FC monitoring is
presently under consideration by the sub-Committee
of FSDC.
5.4.3 The Joint Forum6, BCBS has spelt out the norms
for identification of Group-level supervisor (Lead
Supervisor) with clearly delineated responsibility for
ensuring effective and comprehensive group-level
supervision, including a coordination process. Further,
effective implementation of FC supervision, the role
of the supervisors has been spelt out as under:
-
Clarity in objectives and responsibilities
of each supervisor for effectiveness of FC
supervision
-
Arrangements for information flows and
coordination
-
Measures to enhance coordination to
enable effective group-wide supervision,
including sharing of information
-
Establish appropriate coordination
mechanisms to exchange possible crosssectoral
and cross-border exposures to
each other
-
Develop, implement and maintain
coordination arrangements for normal and
stress situations
-
Have confidentiality arrangement for
information received from other
supervisors keeping in view the extant
legal provisions and
-
Arrangements for resolving differences
between supervisors.
5.5 Views of the Committee
5.5.1 Due to the presence of multiple regulators in
the financial sector, supervisory cooperation amongst
the sectoral regulators has been necessitated from the
perspective of preventing “supervisory arbitrage”,
undertaking effective Consolidated Supervision and
maintaining systemic stability. It, therefore, becomes
imperative for the sectoral supervisors to appreciate
their specific roles and responsibilities in supervision
of a material part of a bigger financial group. The
Consultative document of the BCBS has included
“Cooperation and collaboration”7 as a separate Core
Principle with emphasis on cooperation, including
analysis and sharing of information, and undertaking
joint work, with all domestic supervisors. To facilitate
flow of information and have a coordinated approach
towards issues of concern, the Committee suggests that
a mechanism of structured exchange of information
and cooperation be developed amongst the sectoral
supervisors. An arrangement through a formal MoU is
desirable.
5.5.2 Presently, the Consolidated Supervision of FCs
is being undertaken through a mechanism of “lead
regulator”, wherein the respective sectoral regulator of
the “parent entity” of the group is also responsible for
the consolidation supervision of the group. The
Committee if of the opinion that such an institutional
arrangement with FSDC at the apex level for coordination
amongst regulators and periodic meetings with FCs is
adequate in the Indian context. However the level of
coordination amongst regulators for effective FC
supervision would need to be enhanced under the aegis
of FSDC. Further, to address the issues of systemic
stability due to the operations of FCs, an integrated
approach to collection of supervisory data of systemic
importance (like intergroup financial transactions
amongst FC) would be desirable.
Recovery and resolution mechanism
5.5.3 The objective of an effective recovery and
resolution regime for banks is to make feasible the
resolution of banks without severe systemic disruption
and resorting to taxpayer support of banks. While, a
recovery plan is prepared by the bank identifying
options to restore financial strength and viability when
the bank comes under severe stress /financial loss, the
resolution plan is intended to facilitate the effective
use of resolution powers entrusted in the supervisor
to determine a detailed roadmap to resolve a failed
financial institution without severe disruption and
resorting to government bailouts.
5.5.4 The Committee while deliberating on the issue
has taken note of the importance of an effective
Recovery and Resolution Plan (RRP) in India. After the
Financial Crisis in 2008, the RRP have received increased
international attention. The FSB has also placed a
discussion paper for future implementation amongst
its members. Against this backdrop, the Committee has
noted that in future, India too will be obligated to
initiate necessary changes in the legislation and
regulations for Indian banks and also internationally
active foreign banks in India and resolution plan of
their parent to align them with FSB recommendations.
The Committee notes that resolution planning has
major connotation on financial stability considerations
and thus the FSDC could be the appropriate forum.
However, as the initial point of contact with bank, it is
incumbent on the part of the supervisor to be sensitive
to the need of having and ensuring the operational
capability and effectiveness of any RRP as per the extant
legal /regulatory provisions. In view of the importance
of RRP, the Committee is of the view that a separate
group may study the aspects in depth.
5.6 Cross- Border (Overseas)
5.6.1 An essential criterion for the host country in
permitting cross-border banking operations is the
efficacy of the home supervisor practices on global
consolidated supervision. To be able to undertake
effective cross-border supervision, it becomes
imperative that the home supervisor develops an
agreed communication strategy and put in place
information sharing arrangement on reciprocal basis
with host supervisor. Underlining the importance of
Home-host relationship in cross-border supervision,
the consultative document of Core Principles, March
2012 (Principle 13: Home-host relationships) of
Effective Banking Supervision issued by the Basel
Committee of Banking Supervision (BCBS) has stated:
“Home and host supervisors of cross-border banking
groups share information and cooperate for effective
supervision of the group and group entities, and
effective handling of crisis situations. Supervisors
require the local operations of foreign banks to be
conducted to the same standards as those required of
domestic banks.”
Operations of Foreign banks in India
5.6.2 Foreign banks in India have been operating as
branches of international bank /banking group and are
thus not required to prepare CFS under Accounting
Standard 21 (AS 21). However, they submit CPR
consolidating the NBFCs with the bank’s Indian
operations. Further, prudential norms as prescribed
under CPR are also applicable to foreign banks. While
accounting consolidation of foreign bank’s associates/
affiliates and sister concerns are not feasible due to
their corporate structure, supplementary Consolidated
Supervision for three large and complex foreign banks
is being done.
5.6.3 Although a large number of foreign banks have
presence in India, a vast majority of them have less
than two branches. Some of these banks however have
substantial off-balance assets which make them
significant from a supervisory standpoint. Few of these
banks are considered large and complex and are subject
to close and continuous supervision. RBI has been
giving ‘no objection’ on reciprocal basis to overseas
supervisors to inspect branches of home country banks
operating in India. RBI supervisors have also been
attending the supervisory colleges of some of the big
global banks /banking groups on invitation from the
home country supervisors.
Overseas operations of Indian banks
5.6.4 Over the years, a large number of Indian
banks have established sizeable overseas presence
through branches, subsidiaries, joint ventures and
representative offices network. United Kingdom, Hong
Kong, Singapore, United States of America, UAE and
Bahrain in Middle East account for a sizeable share
(83.81%) in the total assets of Indian banks deployed
in overseas centers. While the average percentage of
overseas assets to total Global assets of these Indian
banks is around 10%, for a couple of banks this ratio is
higher than 20% indicating significant international
presence.
5.6.5 The system of off-site supervision of the
overseas branches of Indian banks by RBI is broadly on
a pattern similar to those applicable to bank’s domestic
operations. The banks are required to furnish
information on exposures to borrowers, for liquidity
and for country risk management in addition to
financial information on overseas operations of the
bank under OSMOS. In addition to these structured
returns, information on overseas frauds, defaults,
regulatory observations, business environment, audit,
credit and control areas are reported in unstructured
form (outside OSMOS system).
5.6.6 While the overseas operations of Indian banks
operating abroad are guided by the host country’s
regulations, RBI intermittently undertakes onsite
inspection of overseas branch/ subsidiaries subject to
permission from the host regulator. The cross border
operations of Indian banks have expanded significantly
during the last few years. RBI has recently started
entering into MoUs with overseas banking supervisors
for facilitating effective cross-border supervision.
Supervisory Colleges for Indian Banks
5.6.7 In India, at present no supervisory colleges
have been set up for any bank/ banking group. However,
RBI has been attending the supervisory colleges of some
of the major foreign banks operating in India whenever
invited by overseas Supervisors/ Central Banks.
5.6.8 Supervisory Colleges as a form of supervisory
tool for information sharing are operational in many
jurisdictions. The primary objective of a supervisory
college is to assess and develop an understanding of
the risk profile of an international banking group of
which the home supervisor is also the lead supervisor.
As the consolidating supervisor, the home supervisor
has the largest stake in effective functioning of the
supervisory college. Over time, the supervisory colleges
have also developed as a forum for broader issues such
as discussions and planning of supervisory assessments
and sharing information about the overall risk
assessment of banking entities as well as the banking
group. The BCBS8 stated that the objective of Supervisory
Colleges should be to “enhance information exchange
and cooperation between supervisors to support the
effective supervision of international banking groups.
Colleges should enhance the mutual trust and
appreciation of needs and responsibilities on which
supervisory relationships are built”.
5.7 Views of the Committee
5.7.1 The overseas operations of Indian banks are
supervised by the respective national supervisors.
While there has been a conscious and ongoing effort
on part of supervisors of major economic jurisdictions
to align their supervisory practices with the global best
practices, some of the overseas jurisdictions where the
Indian banks are operational may are ‘perceived’ to
have less stringent supervisory framework than
existing in India. As the home regulator, it thus
becomes incumbent upon RBI to keenly assess the
extant supervisory regimes in such jurisdictions and
require the Indian banks to establish comprehensive
risk management guidelines for their overseas
operations and meticulously observe them so as to
guard against greater supervisory and economic risks.
5.7.2 Notwithstanding the supervision by the host
country, RBI as the home supervisor will not be able to
have a comprehensive view of the bank’s operation
without an on-site examination of some of the branches
and subsidiaries whose operations pose a higher risk
to the overall soundness of the parent bank in India.
The Committee also notes that in respect of some of
the Indian banks, the capability and expertise of the
Boards of Directors and Top Managements for assessing
the international operation of banks is limited. In this
context, the findings of onsite supervision of bank’s
operations would provide valuable insight and inputs
for the board of the bank and improving their risk
management. Also, the supervisor would be able to
have a better assessment of the overseas risk on the
parent bank. Such exercise also exposes the supervisory
staff to the extant supervisory environment in other
jurisdictions.
5.7.3 In accordance with the BCBS Principles (October
1996), a formal arrangement for supervisory cooperation
with overseas supervisors through a Memorandum of
Understanding (MoU) is considered essential. The
terms and conditions of the MoUs entered into by RBI
with host country supervisors would determine the
supervisory approach and the focus on overseas
operations of globally active Indian banks. In this
context, the Committee notes that the current process
of RBI entering into MoUs with overseas bank
supervisors is desirable and needs to be pursued
further.
5.7.4 The growing global activities of some of the
large Indian banks have necessitated putting in place
a formal mechanism of supervisory cooperation and
information exchange with host supervisors for
effective cross-border Consolidated Supervision. The
Committee thus recommends setting up of supervisory
colleges in respect of large globally active Indian banks
having significant (Say 15%) share of assets from foreign
operations as a percentage of total assets.
CHAPTER 6
INSTITUTIONAL STRUCTURE AND HUMAN RESOURCES
Corporate Governance in Banks
6.1 Introduction
6.1.1 According to Organization for Economic Cooperation
and Development (OECD), the Corporate
Governance structure specifies the distribution of rights
and responsibilities among different participants in the
corporation such as the board, managers, shareholders
and other stakeholders as well as spells out the rules
and procedures for making decisions on corporate
affairs. Advisory Group on Corporate Governance under
the chairmanship of Mr. R. H. Patil defined corporate
governance as the system by which business entities
are monitored, managed, and controlled.
6.1.2 The Board and Top Management of a bank are
the first line of defense for the material risks that face
a bank. World over, there has been a growing recognition
that the risk management framework and processes
alone may not be sufficient to control the risks in a
bank unless there is an effective corporate governance
system in place. While the Board and Management of
a bank are responsible for good governance and
performance of the bank, it is the supervisor’s role to
assess and ensure that banks follow good corporate
governance practices. Recognizing the importance of
corporate governance as a key to effective supervision,
the Basel Committee on Banking Supervision (BCBS) in
its guidance note of October 2010 recommended:
“Supervisors should regularly perform a comprehensive
evaluation of a bank’s overall corporate governance
policies and practices and evaluate the bank’s
implementation of the principles.”
6.1.3 The BCBS has identified six key areas of
corporate governance in banks indicating the best
practices standards for banks on these parameters for
greatest supervisory focus and attention. The six key
areas include: (i) Board practices; (ii) Senior
management’s accountability; (iii) Risk management
and internal controls; (iv) Compensation; (v) Complex or opaque corporate structures and (vi) Disclosure and
transparency.
6.2 Evolution of Corporate Governance of Banks in
India
6.2.1 In the pre-reform era wherein the public sector
banks were dominant with relatively few private banks,
there were very few regulatory guidelines covering
corporate governance of banks. However, in the post
reform era, the government shareholding in public
sector banks was diluted and a larger number of private
sector banks entered the banking arena. Due to
competition faced from private sector banks, the public
sector banks were accorded larger autonomy with bigger
responsibility. With the Board being given the flexibility
to draw up their own business plans, it became
imperative for the board members to be more
knowledgeable and be professionally aware of policy
choices.
6.2.2 A general overarching corporate governance
structure is stipulated particularly in respect of the
listed companies. Clause 49 of the Listing Agreement
put out by SEBI, deals with the corporate governance
aspect for the listed companies and cuts across all
sectors in India. In addition, extensive sectoral
guidelines are in place for the banking companies in
the form of statutory provisions under the Banking
Regulation Act, 1949. The recommendations of Dr.
Ganguly Committee on corporate governance also
served as regulatory framework on corporate governance
for banks.
6.2.3 Some of the other measures initiated by the
Reserve Bank to strengthen the corporate governance
in the Indian banking sector include:
-
Distancing the regulator from the
functioning of the Boards (Reserve Bank
has withdrawn its nominee directors from
almost all the private sector banks);
-
Legislative amendments in regard to the
public sector banks to remove the
provisions for mandatory nomination of
RBI officers on their boards;
-
Sensitized the Government to keep in view
the policy framework for governance in
private sector banks while deciding on the
appointment of the directors on the Boards
of public sector banks and constitution of
various committees of the Board;
-
Established a uniform regulatory
framework for public and private sector
banks by reviewing existing instructions
specifically applicable to the public sector
banks; and
-
Enhanced RBI’s capacity to ensure sound
governance especially relevant to the
banks, consistent with global best practices
by several amendments to the Banking
Regulation Act, 1949.
6.3 Supervisory Concerns on Corporate Governance
Fit and Proper Criteria for Nominee Directors, CEOs
6.3.1 Though the extant criteria stipulated specific
areas of background (such as accountancy, banking,
economics, finance, agriculture, etc) that a Board of
director should be drawn from, it does not specify the
extent or degree of professionalism or expertise
required in regard to that area. There is no legal
provision as of now for the Reserve Bank to insist on
the ‘fit and proper’ for the directors nominated by the
government or elected by the shareholders to the
Boards of the public sector banks. The appointment of
the CEOs in the public sector banks, as well as their
removal, is solely under the discretion of the
Government.
Splitting the Posts of Chairman and CEO of Banks
6.3.2 With a view to bringing about transparency and
efficiency in the working of the Board and Senior
Management of banks, Ganguly Committee had
recommended bifurcation of the posts of the Chairman
of the Board and the CEO of the bank. Since 2007, the
Reserve Bank has implemented this recommendation in all the private sector banks. Ganguly Committee
recommendations to this effect have also been echoed
by the aforesaid BCBS paper titled, ‘Principles for
Enhancing Corporate Governance’ put out in October
2010.
Compensation
6.3.3 It is generally accepted that the flawed and
perverse compensation structures for banks’ top
management in the advanced economies were one of
the significant drivers for the 2008-09 economic crisis.
The prevalent compensation structures rewarded bank
management which was able to generate greater profits
at the expense of overlooking hidden risks. The
Financial Stability Board (FSB) has since evolved a set
of principles to govern compensation practices and the
Basel Committee has developed a methodology for
assessing compliance with these principles. The
proposed framework involves increasing the proportion
of variable pay, aligning it with long-term value creation
and instituting deferral and claw-back clauses to offset
future losses caused by the executive. The Reserve Bank
has the power, in terms of the Banking Regulation Act,
1949 to regulate board compensation, including the pay
and perquisites of the CEOs of private sector banks. In
evaluating compensation proposals for whole-time
directors and CEOs of private sector banks, the Reserve
Bank is guided by relevant factors such as the
performance of the bank, compensation structures in
the peer group, industry practices and regulatory
concerns, if any. As regards bonus, the Reserve Bank
from time to time, has issued guidelines restricting
levels of bonus to be paid to them and to other
employees of the bank in respect of whole-time
directors and CEOs. Post-crisis, responding to a public
voice on the need for reform the Reserve Bank in
January 2012 issued guidelines on ‘Compensation of
Whole-Time Directors /Chief Executive Officers /Risk-
Takers and Control Staff’, which proposed that banks
should have a compensation policy in place to align
compensation structures with prudent risk taking and
institute a claw-back mechanism. These guidelines are
for implementation by private sector and foreign banks
from the financial year 2012-13.
Conflicts of interest
6.3.4 Conflicts of interest may arise as a result of the
various activities and roles of the bank or between the
interests of the bank, its customers, board members or
senior managers. Conflicts of interest may also arise
when a bank is part of a broader banking group. It thus
becomes imperative that the board ensures that policies
are in place to identify and mitigate potential conflicts
of interest. To achieve transparency in this process, the
Committee is of the view that the board should have a
formal written conflicts of interest policy and an
objective compliance process for implementing the
policy.
Succession Planning
6.3.5 Succession planning is key to business
continuity for any organization, especially for
commercial and corporate entities such as a bank.
Grooming future leaders is a process which often needs
time and investments by the organization. At some
point in the future a successor will be required to
continue the management of the organization. Plans
for succession should consider a variety of scenarios,
such as a CEO’s retirement at an appropriate age, a
CEO’s decision to leave and give notice, medical or
other emergency (illness or temporary absence of CEO)
or untimely death. The board should develop a pool of
prospective replacements by identifying, talents and
leadership potentials at an early stage and groom them.
In this context, the Board and top management can
play an important role in ensuring smooth transitioning
and succession. Nepotism, favouritism and biases are
detrimental to professional bodies particularly in banks
which are not only reposed with shareholders’ but also
depositors’ trust. While orderly succession can be
planned well in advance, often the Boards of banks are
not prepared to handle crisis situations wherein most
of the Top Management functionaries resigned /leave
enmass. The new incumbent is often clueless to most
of the ills which the previous management would have
perpetrated and thus is disadvantaged in taking
remedial measures. Such situations have come to fore
during the 2008-09 Crisis in some jurisdictions. A case
of mismanaged succession also happens when
supercession of some of the senior management causes their exodus due to dissatisfaction with the succession
change.
6.4 Views of the Committee
6.4.1 On the role of a bank’s board, members of the
Committee are unanimous in their view on the
predominant role that the Board of directors of the
banks should play in the risk management of the bank.
The Committee is of the view that a bank’s board is the
first line of defense against any threat of material risk
and irrespective of risk management framework and
risk control structures that may be in place, it is the
willingness of the board and senior management to act
and their effectiveness which can efficiently remedy
the adverse situations.
6.4.2 On the issue of separating the posts of
Chairman of the board and CEO the Committee is of
the view that given the positive experience in India as
well as the global endorsement for this position, the
natural course of future actions would be to see if
similar separation of the posts of chairman of the board
and the CEO could be extended to public sector banks.
An important criterion for enforcing the same would
be the extent to which strict eligibility criteria for the
position of the chairman of the board of a public sector
bank can be laid down and enforced.
6.4.3 On succession planning, the Committee
recommends that the supervisory assessment of banks’
governance on this aspect should be proactive,
intermittent and specific with realistic suggestions.
6.4.4 Unlike corporates, the failure of a bank has
ramifications not only amongst the shareholders, but
also the depositors. The scourge of contagion and its
ramifications for the entire financial system and the
economy further compounds the impact of its failure.
Considering the inter-linkages with the financial
system, the responsibility for depositor protection
through sound and effective corporate governance
becomes paramount in efficient functioning of the
banking system.
6.4.5 In emerging economies like India, banks are
more than mere agents of financial intermediation as
they carry the additional responsibility of leading financial sector development and of driving the
government’s social agenda. Besides, the institutional
structures that define the boundaries between the
regulators and the regulated and across regulators are
still evolving in emerging economies. Managing the
tensions that arise out of these factors makes corporate
governance of banks in emerging economies even more
challenging. In the light of the foregoing, the Committee
is of the view that corporate governance can be
considered effective only if board and senior
management in banks pass the fitness, suitability and
appropriateness tests and are further supported by
robust and active risk management and internal control
functions. The safety and soundness of a bank is thus
driven by the triad – corporate governance supported
by effective risk management and internal control
system. Hence the Committee recommends the
following agenda for the supervisor to ensure that the
above-mentioned triad is strengthened in the banks:
(i) Supervisor must assess bank’s Corporate
Management structures and practices together with
its Risk Management as integral parts and not in
isolation to establish that risk management
functions are in alignment with business processes
of the bank and not in silos.
(ii) Supervisor must assess the role of the Board in
providing guidance on bank’s strategic objectives,
risk strategy, corporate governance and corporate
values as well as its effectiveness in providing
oversight to the Senior Management. In this
context, the supervisor may also assess the
competence of the Board members vis- a-vis their
qualification, experience and understanding of key
affairs of the bank;
(iii) The Supervisor must sensitize the Board about the
need for sustained efforts to build leaders and
groom potential leaders early in their career.
Supervisor must also comment on the deficiencies
in succession plan and practices of the bank;
(iv) In case of banking group, the supervisor should
asses and establish whether the board of the parent
entity has the overall responsibility for adequate
corporate governance across the group and whether the board was ensuring that there are governance
policies and mechanisms appropriate to the
structure, business and risks of the group and its
entities;
(v) Supervisor should focus on bank’s compliance to
the best practices on corporate governance, which
include:-
-
Adherence to the Fit and Proper criteria for
board members, ensuring the right mix of
specialists on the board, especially at least
one Risk Management specialist on the
board;
-
Risk management structure, internal
control system and functions - a separate
and independent Risk Department headed
by the Chief Risk Officer. The board and
senior management should know and
understand the bank’s operational structure
and the risks that it poses (“know-yourstructure”
as per BCBS Principle No. 12 on
Corporate Governance, October 2010);
-
Independent board Committees like
Risk Committee, Audit Committee,
Compensation Committee, HR or
Governance Committee, Ethics /
Compliance Committee - ensuring that
these committees have an optimal mix of
skills and experiences that, in combination,
allow the committees to fully understand
and objectively evaluate and bring fresh
thinking to the relevant issues. In order to
achieve the needed objectivity, membership
should be composed of non-executives and
to the extent possible, a majority of
independent members;
-
Of the specialized Board Committees,
supervisors should ensure that the Risk
Committee and the Audit Committee
report directly to the board;
-
Supervisors should have direct interaction
with the specialist committees like audit,
risk management, etc. to better understand the bank’s functioning in these key areas
which are of concern to the supervisors;
-
Supervisors must focus on the transparency
or otherwise of the corporate governance
structure and function in the bank; and
-
Supervisors to check bank’s adherence to
arms length principle and conflict of
interest policy.
Accountability of the Board /Top Management of the
bank
6.4.6 While the actions or inaction of the Top
management of a bank has a direct bearing on the
depositor’s interest, their accountability and
responsibility to their depositor is limited. The Board
of the bank and its management are primarily
accountable to the shareholders. The Committee is of
the view that the accountability of the board and top
management needs to be enhanced and put to greater
scrutiny by the supervisor. Some of the supervisory
measures that could improve the accountability of the
bank’s Board/Top management include the following:
-
Presently, the deliberations/discussions of the
proceedings of the meetings of the Board and
its committees are primarily written as
minutes. Often the observations and
reservations, if any expressed by Board
members are not adequately captured through
these minutes. The Committee recommends
that the proceedings of the Board and its
important committees may be either written
in detail as “Talking Minutes” or audio/video
recorded and preserved. Preservation and
Access Policy may be framed to maintain
secrecy and accessibility for evaluation of the
performance of Board members by Regulator/
GOI. This will also be helpful in ascertaining
the ‘fit and proper criteria’ in assessment of
future appointments;
-
The supervisor may explicitly outline the
responsibilities of the Board, which among
others should include the role of the Board in
formulating strategies and preparation of
Business Plan, review the progress and business performance against board approved plans and
strategy; and
-
The AFI report on management of banks should
sufficiently focus on the control function of
management on articulating clear business
plans, risk drivers and risk mitigation plans.
Institutional Structure and Human Resources
6.5 Introduction
6.5.1 The growing complexity of banking operations
across the globe has posed a question about an optimal
structure for bank supervisors. Organizational
structures of the supervisory setup are designed to be
effective in their respective economic environments,
jurisdiction and given cultures. Certain attributes which
provide basic criteria for the supervisors to be effective
have normally been understood and broadly identified.
For instance, the IMF Internal Staff Note indicates the
attributes that enable the supervisors to act include
Legal authority, Adequate Resources, Clear Strategy,
Robust internal organization and Effective working
relationships with other agencies. Thus, adequacy of
resources and robustness of the internal organization
are central to building a strong, effective and efficient
supervisory setup in any jurisdiction.
6.6 Present Supervisory Setup in the RBI
6.6.1 Structure of BFS
Board for Financial Supervision (BFS) with
Governor, RBI as the Chairman, Deputy Governor In-
Charge of the Department of Banking Supervision as
the Vice Chairman is at the apex of the supervisory
structure in RBI. BFS oversees the functioning of
Department of Banking Supervision (DBS), Department
of Non-Banking Supervision (DNBS), Financial
Institutions Division (FID) and Urban Banks Department
(UBD) and gives directions on the regulatory and
supervisory issues. BFS from time to time also gives
directions on system of bank inspections, off-site
surveillance, strengthening of the role of statutory
auditors and strengthening of the internal defences of
supervised institutions. The Audit Sub-committee of
BFS oversees the system of concurrent audit, norms of
empanelment and appointment of statutory auditors, the quality and coverage of statutory audit reports, and
the important issue of greater transparency and
disclosure in the published accounts of supervised
institutions. The BFS approves policies and issues
general guidance /instructions in the matters of banking
supervision. It also issues directions/ orders for specific
supervisory actions in respect of individual banks. BFS
awards the rating to individual banks based on the AFI
findings. The Central Office of the DBS provides
Secretariat to the BFS, processing information for and
executing decisions of the BFS.
6.7 Views of the Committee
General
6.7.1 Presently the bulk of off-site monitoring of
banks is done at Central office of DBS, while the
supervision of banks is undertaken primarily through
the various Regional Offices of the department, except
in case of twelve large and Complex banks for which
both offsite and onsite supervision are integrated at
the Central office level.
6.7.2 There is thus a need and scope for better
coordination between the Regional Offices and the
Central Office of DBS through exchange of information
and coordination for leveraging the off-site supervision
into the onsite inspection process. Further, for optimum
utilization of the available supervisory resources, the
combined pool of both Regional and Central Office
needs to be taken into account.
6.7.3 Owing to the way the regulatory and supervisory
departments are structured in RBI, presently, the
commercial banks have to deal with different
departments for seeking regulatory/supervisory
clarifications. For example, for the primary dealership
business, non bank financial activities, foreign exchange
business etc. being conducted within the same banking
group- either departmentally or through a subsidiary
mode, a bank would have to approach different
departments in RBI leading to uncoordinated
supervisory responses and information gaps.
6.7.4 The multiple points of contact for the banks
within RBI impedes the efficiency and effectiveness of
the supervisory processes resulting in supervisory
blind spots and undermining an effective Consolidated
Supervision of the commercial banks. In this regard, the Committee is of the view that while there is a need
to have clear separation between the regulatory and
supervisory departments at operational levels,
wherever feasible, all the supervisory functions within
the RBI that have a bearing on the operations of a
commercial bank need to be brought together for an
improved Consolidated Supervision.
6.7.5 From a supervisory standpoint, it is essential
that the DBS is aware of all interactions/exchanges that
other regulatory /supervisory departments within RBI
have with the bank. In this regard, the Committee
recommends that for ensuring an effective supervisory
mechanism, a single point of supervisory contact
should be established for the banks within RBI
(Department of Banking Supervision). The objective of
establishing the single point of contact would be to
ensure that supervisory department’s views and
recommendations are obtained on all references
received from the banks and the supervisor is aware
of all communications made with individual banks
from within RBI. In this context, the Committee also
recommends that this single point of contact should
be in the form of a Supervisory Relationship Manager
/ Desk Officer for each individual bank. As the work
assigned to the ‘Supervisory Relationship Manager
(SRM)’ will be multifaceted in nature, it would be
essential to mandate minimum qualification of
expertise / experience, keeping in view the profile of
the bank. The SRM of each bank being the focal point
and common reference point for both the bank as well
as other departments of RBI would be expected to
undertake a wide range of activities pertaining to the
specific bank. While for larger and more complex banks,
more than one SRM may be necessary, one of which
would act as the nodal officer for interacting with the
bank.
Role of Supervisory Relationship Manager
6.7.6 Some of the important roles and responsibilities
of the SRM as envisaged by the Committee are as under:
-
Maintain a continuity of knowledge about
the bank (building bank profile, Risk
Templates and risk profile) within the
supervisory department of RBI and shall
be well versed with the history of the bank’s AFI observations, risk assessments
and other supervisory issues;
-
Shall be a reference point for all interactions,
including correspondences between the
bank and the RBI on all supervisory issues;
-
Involve in offsite monitoring of banks as
well as in the supervisory activities
including onsite supervision, SREP, rating
etc;
-
Provide and respond to periodic information
requests from other departments of RBI
which can be extracted from the common
central database under the umbrella
supervisory department; and
-
Assist the bank in entity-specific decisions
/approvals by expeditiously liaising with
other departments of the RBI internally.
6.7.7 To be effective in discharging the role of a SRM,
it would be imperative that the SRM requires stability
and continuity over a reasonably long tenure. The
Committee thus recommends that the role of the SRM
be institutionalized within the supervisory department
by clearly identifying job description and accountability.
A dedicated team of examiners may be identified and
stationed at the Central Office of DBS to provide
assistance to all the SRMs in conducting Thematic
Reviews, Targeted Reviews of functional areas and
product lines during a supervisory cycle.
6.8 Supervisory Skills
6.8.1 Of late, the degree of sophistication and
complexity of banking activities has increased
substantially. In this context, the report of the Internal
Working Group on Human Resources in DBOD and DBS
(2006) had made broad recommendations for (a) entry
point norms for posting of staff to these Departments,
(b) longer tenure for officers posted to these departments
(a minimum of 7 years), (c) Optimal allocation of
resources to the Regulatory and the Supervisory
Departments etc. The Technical Note of the Financial
Sector Assessment Program (FSAP) - India (October
2011) has also made incisive remarks regarding the
need for training and specialization for bank supervisors.
6.8.2 At present, there is no accreditation program
for bank inspectors. The Committee suggests introduction of an “inspector certification” program for
all bank supervisors in the supervisory department.
The certification program could include a well-defined
training module along with on-the-job training to enable
the bank examiners gain a requisite level of knowledge
and experience before determining their readiness to
receive the inspector certificate. The Committee is also
of the view that the Rotational assignments in other
departments should be a means of broadening an
individual’s knowledge and skills and not the end of a
career as a bank supervisor. Some of the approaches
that could achieve this objective include:
-
Focus on rotation of supervisory personnel
primarily with other departments /
functions that are supervisory in nature
(including regulatory departments), rather
than moving supervisory personnel to
non-supervisory Departments, or moving
people from non-supervisory Departments
into supervisory ones.
-
Identify and limit the number of people
for broad rotations across the RBI to a small
percentage of overall staff. There is a clear
value in having a cadre of people with
broad experience across the central bank,
but the absolute number of such true
generalists can be quite small and still
accomplish the objective of developing
future generations of RBI leadership.
Training
6.8.3 Training and development are essential in
building a pool of skilled, knowledgeable and competent
staff. Ideally, training should combine formal
instructions with case study, seminars and on-the-job
experience. Also, opportunities to interact with
supervisors from other jurisdictions help in keeping
abreast with latest developments and cross-fertilization
of ideas. Presently, the RBI has been drawing up the
training and development programmes for its
supervisory staff which include:
-
In-house departmental training
programmes by drawing resource persons
from India and abroad;
-
External training programmes at Reserve
Bank Staff College, Chennai and College of
Agriculture & Banking, Pune; and
-
Foreign Training through tie-up
arrangements with BIS, FSA, IMF etc
including occasional deputation to various
Central Banks or International Financial
Institutions etc.
6.8.4 The Committee is of the view that while the
current training programmes for supervisors within
RBI provide adequate scope and opportunities for skill
updation of officers, they do not focus on developing
specialists within the supervisory department. Also,
amongst the supervisory staff, the level of skill and
experience has wide variance. The Committee therefore
recommends that for undertaking key supervisory roles
in specialized areas of risk management and modelling,
treasury, credit, operational risk, and assuming the role
of lead /principal inspecting officer, the supervisory
staff should have an acceptable base level of knowledge
/skill and experience especially those who are involved
in supervision of banks having large and complex
operations. Additionally, for undertaking general
supervisory activities, accreditation with specific
programs and training designed for AML /KYC, off-site
supervision, customer service, accounting etc. is
desirable. To be able to develop a pool of supervisory
resources, the supervisory department would need to
plan and identify areas of expertise and also identify
officers going forward.
Specialization
6.8.5 The world over, supervisors have not only taken
cognizance of the changing landscape of banking
activities but also promptly responded to the compelling
need to have supervisory inputs from specialists in
various functional areas of the banks. In this context ,
RBI, in its Internal Working Group report on Human
Resources in DBOD and DBS (2006) had identified
certain areas of specialization which included Risk
Analysis / Management (RAM), Basel II implementation,
‘Policy Research, Analysis and Intelligence’, Supervision
/ Regulation of Complex and Conglomerate Banks and
Legal affairs. The role of specialists becomes more pronounced in Risk Based Supervision of banks,
wherein in most jurisdictions, the existing supervisory
resources are supplemented with specialists in areas
of Risk Management, modeling etc. The Committee is
of the view that the need to create a knowledge pool
of specialists is rather urgent and pressing for the RBI.
In this context, the Committee has noted the inherent
limitations in updation of skill sets of the RBI’s internal
supervisory staff. The Committee therefore
recommends specific shortfalls may be met by engaging
the services of external agencies to train and adequately
equip existing staff.
6.8.6 There is a need to upgrade the supervisory
resources in some of the non-core supervision areas
like IT audit, forensic audit etc. While external
specialized agencies may be hired for undertaking such
activities on need basis, the Committee is of the view
that RBI should ensure that in the long run it is able to
develop its own pool of resources in these non-core
areas also. To this end, the Committee suggests that at
the time of hiring any external agency for undertaking
certain non-core supervisory activities, the in-house
supervisors should also accompany and participate in
such assignments in order to gain the required
experience and expertise.
6.8.7 The Committee believes that there is an
imperative need for specialist supervisors having
adequate knowledge in the areas of risk assessment
and measurement. As in other major supervisory
jurisdictions, the supervisory resource pool needs to
be strengthened with external experts. In this context,
the Committee recommends that in order to create a
pool of domain experts within RBI, a system of
continuous movement of people from RBI to external
organizations i.e. commercial banks (in areas like risk
management, financial engineering, treasury operations,
capital planning etc), accounting firms, academia,
capital market, brokerages, legal firms etc. and vice versa
should be instituted. This needs to be encouraged
through well-defined career progression programme
and made an integral part of HRM function within RBI.
In this context, it is important that vertical movement
within the department and the organization needs to
be replaced by horizontal/vertical movement from other
areas/functions etc. within and outside RBI.
CHAPTER 7
SUMMARY OF MAJOR RECOMMENDATIONS
A summary of major recommendations of HLSC
indicating the relevant paragraph numbers in the
Report is as under:
7.1 Supervisory Approach
Objectives of Supervision
7.1.1 While the protection of depositors’ interests
should be the primary objective of RBI’s supervisory
process, promotion of financial stability and customers’
protection should also be articulated as overarching
objective of RBI’s supervision. (2.6.5 & 2.6.6)
Approach to Supervision
7.1.2 In view of the emerging challenges and
ensuring optimization of supervisory resources, a riskbased
approach for supervision for commercial banks
in India is recommended. It is imperative that each
bank has a certain basic risk management framework
in place before the Risk Based Supervision can be rolled
out. Accordingly, the Committee has outlined the
ingredients of a baseline risk management framework
and suggests that full-scale RBS should be implemented
across the banking industry from 2013 Supervisory
cycle. (2.6.27)
7.1.3 The Committee recommends that along with
focus on supervision of banks on a solo basis, RBI
should also focus on Consolidated Supervision of
banking groups. In view of the fragmented set up within
RBI for supervising different entities belonging to the
same banking group, the Committee recommends that
a single point contact in the form of a ‘Supervisory
Relationship Manager’ should be created within the
Department of Banking Supervision to ensure efficient
and effective communication between the supervisor
and the supervised entities and to aid the Consolidated
Supervision process. (2.6.15 & 2.6.18)
Jurisdiction of Supervision
7.1.4 The domains of regulation and supervision
should be firmly demarcated and any entity specific
decision should only emanate from the supervisory department. This is necessary for clarity of jurisdiction
for the supervised entity and for making the relationship
manager an effective single point of contact in the
Department of Banking Supervision (DBS). The
communication between the supervisor and the
supervised entity is confidential and should not be
subject to any public scrutiny. (2.6.19)
7.2 Supervisory Methods/Tools under RBS
Off-site Supervision
7.2.1 In view of increased reliance on offsite
supervision under RBS it is important to ensure quality
and integrity of data. Accordingly, the Committee
recommends that manual intervention in the flow of
data to RBI from the supervised entities should be
eliminated and penal provisions should be invoked for
deliberate submission of wrong data/ supervisory
information (2.6.29 & 3.6.4)
On-site Examination
7.2.2 The level of risk and the probable impact of a
bank’s failure rather than the volume of business
should be the determinant of the periodicity/intensity
of on-site examination in banks. In view of continuous
off-site supervision under RBS, a differentiated
approach based on the risk/impact assessment of
individual banks for determining the periodicity of
onsite supervisory examination /reviews (ranging
between 1 to 3 years) is recommended. (2.6.31 & 3.7.16)
Reliance on External Auditors
7.2.3 RBI and the statutory auditors should jointly
work towards a formal code to enlist the mutual
expectations, documentation requirements,
information sharing requirements etc with the objective
of eliminating duplicity of supervisory efforts. (2.6.11
& 2.6.13)
7.2.4 As the branch audit of public sector banks could
be dispensed with or drastically curtailed in future RBI
could commission special audits to probe into specific
areas of concern. (2.6.12)
Interactions with the Top Management of banks
7.2.5 The present system of holding quarterly
discussions with the Top Management of all banks may
be replaced with formal interactions, the periodicity of
which may be determined by the supervisor based on
its risk assessment for a particular bank /banking group.
7.2.6 A mechanism for periodic interaction of
supervisor with the Top Management of the banks at
a common platform for deliberating on issues affecting
the banking sector as a whole, may be put in place as
it would be beneficial for both the supervisor and the
supervised entities. (2.6.33)
7.3 Supervisory Processes
Supervisory Processes under RBS
7.3.1 The proposed supervisory cycle under RBS
would involve six key processes: (i) Understanding the
bank (Bank Profile), (ii) Assessing risks faced by the
bank for supervisory purpose (Risk Assessment /
Matrix), (iii) Scheduling and Planning Supervisory
Activities (Planning for supervisory actions /
interventions), (iv) Defining Examination Activities,
on-site reviews and on-going monitoring (Onsite
Inspection – objective, scope), (v) Inspection Procedure
(Onsite Inspection, conduct of SREP, offsite continuous
supervision) and (vi) Reporting findings and
recommendations and follow-up (Inspection Reports,
Updating of the bank Profile). (3.7.1)
Bank Profile
7.3.2 A profile containing comprehensive yet concise
information about the bank should be prepared and
the same should be updated on an ongoing basis. (3.7.2)
Risk Assessment
7.3.3 The risk assessment process involving updating
bank related information collected from various sources
should be conducted by the supervisor on a continuous
basis. (3.7.3)
7.3.4 Both the risk score and the impact scores
derived from the template based exercise would
determine the Risk –Impact Matrix indices. (3.7.9)
Supervisory Actions /Intervention
7.3.5 In order to ensure consistency/ standardization
of supervisory judgment across the banking system an
objective risk assessment template for identified risk
groups would be used to produce an optimum Risk
Matrix. Towards this end, the Committee desires that
technical inputs from professionals or specialists could
be used to ensure that the risk assessment process is
robust, consistent and conforms to the global standards.
The Committee also recommends that the process of
Risk Assessment must be documented in a Supervisory
Manual and a gist of the risk assessment process may
also be shared with the supervised entities (3.7.13)
Scheduling and Planning Supervisory Activities
7.3.6 The supervisory actions on a bank based on the
perceived risks about the bank, would range from an
on-site inspection (full scale or targeted) to only a
continuous off-site monitoring during a particular year.
In this regard, the Committee is of the view that all
banks, irrespective of their risk profile /outcome of the
risk assessment exercise, should be subjected to an
on-site inspection at least once in three years. The
Committee is of the view that the supervisory action
plan should be shared /discussed with the bank’s senior
management. (3.7.14)
Stress Tests
7.3.7 Stress testing should be an integral part of the
supervisory process and used extensively for
determining the soundness/capital adequacy of banks.
In this regard, reverse stress testing should be
undertaken by the banks with active involvement of
Senior Management. (3.10.2 & 3.10.4)
Thematic Review
7.3.8 Thematic reviews should be increasingly used
under the proposed risk based supervisory framework
for supplementing and enhancing efficiency and
effectiveness of the supervisory process. (3.11.3)
7.4 Supervisory Rating
7.4.1 The existing CAMELS based rating system would
not be appropriate under the risk based approach. Under the RBS, the focus of the rating framework should be to
measure the riskiness of a bank and not to evaluate its
performance. (4.11)
7.4.2 Under the risk focused rating framework, the
riskiness of a bank would be computed using a risk
template for identifying the inherent prudential risk
and the risk control elements for various risk groups.
The outcome of the SREP and the supervisory risk rating
above would be used for determining the nature of
supervisory intervention (for reduction of risk or
prescription for additional capital over and above the
regulatory capital, wherever necessary). (4.14 & 4.21)
Disclosure of rating
7.4.3 In line with the extant international supervisory
practices, the supervisory rating should not be made
public as it is confidential information and can only be
shared with the concerned banks. (4.26)
7.5 Consolidated and Cross Border Supervision
7.5.1 A differentiated and risk focused approach to
Consolidated Supervision with more focused attention
on large and complex banking groups is necessary.
(5.3.2 and 5.3.3)
Understanding Group structure and business
7.5.2 The supervisor should develop clear
understanding of the group structure and share holding
pattern along with major lines of accountability within
the group. (5.3.7)
Governance
7.5.3 For assessing the effectiveness of Governance,
the key parameters would include: (i) Competence (ii)
Strategies and policies (iii) Internal control and audit
including group wide oversight (iv) Internal risk
management structure (v) Policy on Conflict of interest
(vi) Transparency and Public Disclosures. (5.3.8)
Cross- Sector Supervision (Domestic)
7.5.4 To facilitate flow of information and have a
coordinated approach towards issues of concern, a
mechanism for structured exchange of information and
cooperation amongst the sectoral supervisors should
be developed. In this context, a formal MoU is also
desirable. (5.5.1)
Recovery and Resolution Mechanism
7.5.5 In view of the importance of Recovery and
Resolution Planning for banks, the Committee
recommends that a separate group may study the issue
in depth. (5.5.4)
Cross-Border (Overseas)
7.5.6 The Committee recommends setting up of
supervisory colleges in respect of large globally active
Indian banks having significant share of overseas assets
as a percentage of total assets. (5.7.4)
7.6 Institutional Structure and Human Resources
7.6.1 The safety and soundness of a bank is driven
by the triad of Corporate Governance, effective risk
management and internal control systems. There is a
need to strengthen the triad in banks. (6.4.5)
Conflicts of Interest
7.6.2 To achieve transparency in addressing conflicts
of interest, the board should have a formal written
conflicts of interest policy and an objective compliance
process for implementing the policy. (6.3.4)
Segregation of the post of Chairman and CEO
7.6.3 Given the positive experience in India as well
as internationally, separation of the posts of chairman
of the board and the CEO could be extended to public
sector banks. (6.4.2)
Single point of Supervisory Contact
7.6.4 There should be a single point of contact in
DBS in the form of a Supervisory Relationship Manager
/ Desk Officer for each individual bank. As the work
assigned to the ‘Supervisory Relationship Manager’ will
be multifaceted in nature, minimum qualifications of
expertise / experience may be mandated, keeping in
view the profile of the bank. (6.7.5 & 6.7.6)
Developing Supervisory Skills
7.6.5 An “inspector certification” program may be
introduced for all bank supervisors in DBS. (6.8.2)
7.6.6 In view of the inherent limitations in updation
of skill sets of the RBI’s internal supervisory staff,
services of external agencies could be engaged to train
and adequately equip existing staff. (6.8.6)
7.6.7 With a view to creating a pool of domain experts
within RBI, a system of continuous movement of people
from RBI to external organizations i.e. commercial
banks (in areas like risk management, financial
engineering, treasury operations, capital planning etc), accounting firms, academia, capital market, brokerages,
legal firms etc. and vice versa should be instituted. This
needs to be encouraged through well-defined career
progression programme and made an integral part of
HRM function within RBI (6.8.7)
BIBLIOGRAPHY
1. Core Principles for Effective Banking Supervision -
consultative document, Basel Committee on Banking
Supervision (BCBS), (http://www.bis.org/publ/bcbs213.htm), December 2011
2. IMF Staff Note “The Making of Good Supervision:
Learning to Say No”- Jose Viñals and Jonathan
Fiechter (www.imf.org/external/pubs/ft/spn/2010/spn1008.pdf), May 2010
3. Principles for Sound Stress Testing Practices and
Supervision - BCBS, May 2009
4. “Internal Audit function in the banks”- Consultative
paper by BCBS, December 2011
5. Bank Holding Company Supervision Manual, Board
of Governors of the Federal Reserve System , USA
6. The FSA’s Risk-Based Approach, A guide for Non-
Executive Directors(November 2006)
7. Commercial Bank Examination Manual, Board of
Governors of the Federal Reserve System, USA
8. Our Approach to banking supervision, Bank of
England & FSA , May 2011
9. Supervisory Policy Manual, (2012), Hong Kong
Monetary Authority
10. Probability and Impact Rating System (PAIRS, 2010)
Australian Prudential Regulation Authority
11. Supervisory Oversight and Response System (SOARS,
2010) Australian Prudential Regulation Authority
12. Risk-based Supervision Methodology of the HFSA,
(2008) Hungarian Financial Supervisory Authority
13. Supervisory framework ( 2010), Office of the
Superintendent of Financial Institutions (OSFI),
Canada
14. S. Padmanabhan Committee: Inspection of Banks
& Onsite supervision function of Banks
15. Altman, Edward I. “Financial Ratios, Discriminant
Analysis and the Prediction of Corporate
Bankruptcy”. Journal of Finance, (September, 1968).
16. Identification of problem banks and binary choice
models by P Espahbodi, Journal of Banking and
Finance (1991)
17. Early Warning of Bank Failure: A Logit regression
approach by D Martin, Journal of Banking and
Finance (1977)
18. Modelling the bank regulator’s closure option: A
two-step logit regression approach by James B.
Thomson, Journal of Financial Services Research
(1992)
19. The importance of qualitative risk assessment in
banking supervision before and during the crisis
by Thomas Kick & Andreas Pfingsten, Deutsche
Bundsbank (2011)
20. New Quantitative Models of Banking
Supervision(2004), Cooperation of Austrian
Financial Market Authority and Oesterreichische
Nationalbank
21. “Assessments, Large Bank Pricing” A Proposed Rule
by the Federal Deposit Insurance Corporation
(2010)
22. Report of Working Group on Consolidated
Accounting and Other Quantitative Methods to
Facilitate Consolidated Supervision (Chairman: Shri
Vipin Malik), December 2001
23. Consolidated Supervision: Managing the Risks in
a diversified Financial Services Industry, IMF June
2001
24. Report of Working Group on Introduction of
Financial Holding Company (FHC) Structure in
India (Chairperson: Shyamala Gopinath) May, 2011
25. Principles for the supervision of financial
conglomerates-Consultative document, Joint
Forum, BCBS, December 2011
26. Good Practices on principles on supervisory
colleges, BCBS , October 2010,
27. Consolidated Supervision , Work Group No 3 ,
Association of Supervisors of Banks of the America
(ASBA)
28. “Principles for enhancing corporate governance”,
BCBS, (www.bis.org/publ/bcbs176.htm), October
2010
ACRONYMS
AER |
Annual Equivalent Rates |
AFI |
Annual Financial Inspection |
AFR |
Annual Financial Review |
ALE |
Asset Liability & off-balance sheet Exposures |
ALM |
Asset Liability Management |
ALO |
Report on Asset Liability and Exposures |
AML |
Anti-Money Laundering |
AMPI |
Aggregated Micro-Prudential Indicator |
APP |
Annual Perspective Plan |
APR |
Annual Percentage Rates |
AS |
Accounting Standard |
BCBS |
Basel Committee on Banking Supervision |
BFS |
Board for Financial Supervision |
BIS |
Bank of International Settlements |
BR Act |
Banking Regulation Act |
BSA |
Balance Sheet Analysis |
CACS |
Capital adequacy, Asset quality, Compliance and Systems & controls |
CAGR |
Compound Annual Growth Rate |
CALCS |
Capital adequacy, Asset quality, Liquidity, Compliance, and Systems & controls |
CAMELS |
Capital adequacy, Asset quality, Management, Earnings, Liquidity and Systems & controls |
CEBS |
Committee of European Banking Supervisors |
CEM |
Report on Country exposures |
CEO |
Chief Executive Officer |
CET-1 |
Common Equity Tier-1 |
CFS |
Consolidated Financial Statements |
CMD |
Chairman & Managing Director |
CPR |
Consolidated Prudential Reports |
CRAR |
Capital to Risk-weighted Assets Ratio |
CRR |
Cash Reserve Ratio |
DBOD |
Department of Banking Operation and Development |
DBS |
Department of Banking Supervision |
DNBS |
Department of Non-Banking Supervision |
DoS |
Department of Supervision |
EDWP |
Enterprise Data Warehouse Project |
FC |
Financial Conglomerates |
FED |
Foreign Exchange Department Operations and Development |
FHC |
Financial Holding Company |
FI |
Financial Institution |
FID |
Financial Institutions Division |
FMD |
Financial Markets Department |
FSA |
Financial Services Authority |
FSB |
Financial Stability Board |
FSDC |
Financial Stability Development Council |
GDP |
Gross Domestic Product |
HLCCFM |
High Level Coordination Committee on Financial Markets |
HLSC |
High Level Steering Committee |
HR |
Human Resources |
ICAAP |
Internal Capital Adequacy Assessment Process |
ICAI |
Chartered Accountants of India |
IDMD |
Internal Debt Management Department |
IMF |
International Monetary Fund |
IRDA |
Insurance Regulatory and Development Authority |
IRS |
Statement of Interest Rate Sensitivity |
IT |
Information Technology |
ITEs |
Intra-group Transactions and Exposures |
KYC |
Know Your Customer |
LCB |
Large and Complex Bank |
LFAR |
Long Form Audit Report |
LHO |
Local Head Office |
MAP |
Monitorable Action Plan |
MEI |
Macro-Economic Indicator |
MIS |
Management Information System |
MoU |
Memorandum of Understanding |
NBFC |
Non-banking Financial Company |
NPA |
Non-Performing Asset |
OECD |
Organization for Economic Co-operation and Development |
OSMOS |
Offsite Surveillance and Monitoring System |
PCA |
Prompt Corrective Action |
PFRDA |
Pension Fund Regulatory and Development Authority |
PIO |
Principal Inspecting Officer |
QD |
Quarterly Discussion |
QID |
Quarterly Informal Discussion |
RAM |
Risk Analysis / Management |
RAQ |
Report on Asset Quality |
RBI |
Reserve Bank of India |
RBIA |
Risk Based Internal Audit |
RBS |
Risk Based Supervision |
RCA |
Report on Capital Adequacy – Basel I |
RCL |
Report on Connected Lending |
RDBMS |
Relational Database Management System |
RLC |
Report on Large Credits |
RLE |
Report on Large Exposures |
RMS |
Risk Management System |
RoA |
Return on Asset |
ROC |
Report on Ownership and Control |
ROF |
Report on Frauds |
ROP |
Report on Profitability |
ROR |
Report on Operating Results |
RPCD |
Rural Planning and Credit Department |
RPT |
Risk Profile Template |
RRB |
Regional Rural Bank |
RRP |
Recovery and Resolution Plan |
SCB |
Scheduled Commercial Banks |
SCoB |
Scheduled Co-operative banks |
SEBI |
Securities and Exchange Board of India |
SIFI |
Systemically Important Financial Institutions |
SIR |
Statement of Interest Rate Sensitivity – Forex |
SLR |
Statutory Liquidity Ratio |
SREP |
Supervisory Review and Evaluation Process |
SRM |
Supervisory Relationship Manager |
TC |
Technical Committee |
UBD |
Urban Banks Department |
VAR |
Vector Autoregressive |
XBRL |
Extensive Business Reporting Language |
ANNEX
Indicative Risk Assessment Templates
Credit Risk
Inherent Risk Elements
Sr. No. |
Elements |
Norms |
Score |
1. |
Quality of exposures |
|
|
|
(a) Corporate advances |
|
|
|
(i) Ratio of change in RWA for credit risk (on balance sheet items) to change in RWA for total assets (on balance sheet total assets) |
|
|
|
(ii) Percentage of credit exposures (including investments in lieu of advances) in the top 50% of the rating grades above hurdle rate (including hurdle rate) to total rated exposures. At beginning of each supervisory cycle, the range may be reviewed to capture the change in the economic cycle. |
|
|
|
(iii) Un-hedged forex exposure of customers to total forex exposure of the customers with the bank |
|
|
|
(b) Retail advances |
|
|
|
Weighted average LTV of outstanding portfolio (i.e. for the outstanding loan book the weighted average LTV at the time of sanction) |
|
|
|
(c) Investments |
|
|
|
(i) Non-SLR investments in top three rating grades to total non-SLR investments |
|
|
|
(d) Counterparty Bank/FI Risk |
|
|
|
(i) Percentage of exposure in the top 50% of the internal rating grades above hurdle rate (including hurdle rate) to total counterparty exposure |
|
|
|
(e) Off – Balance Sheet Exposures |
|
|
|
(i) Growth in RWA of customer deals for past three years and quantum of change in impact on P&L for corresponding years |
|
|
|
(ii) Amount and number of LCs/BGs devolvement/invocation and by the borrower/bank counterparty over previous year. (This parameter may have to be seen in percentage terms i.e. amount and number of LCs/ BGs devolved /invoked to total amount and number of LCs/BGs outstanding at the beginning of the year) |
|
|
|
(iii) Non-payment of crystallised MTM by the borrower/bank counterparty during the year to total crystallised MTM during the year |
|
|
2. |
Credit Concentrations |
|
|
|
(a) Unsecured exposure (on and off balance sheet) to total exposures |
|
|
|
(b) (i) Commercial Real Estate,
(ii) Capital Market,
(iii) NBFC and
(iv) Commodity sector exposures
(such as gold, food grain and metal exposures through exchanges) |
|
|
|
(c) (i) Industry concentrations |
|
|
|
(ii) Herfindahal Hirschman Index (HHI) for industry wise concentration |
|
|
|
(d) Borrower concentrations exposure of top fifty exposures to total exposures and exposure of top 20 group exposures to total exposures (excluding exposure to quasi regulatory bodies such as NABARD/SIDBI)
- Single borrower and group borrower concentrations (number and amount of excess over regulatory/internal norms) |
|
|
3. |
Country Risk |
|
|
|
(a) Quantum of exposure to medium and high risk countries (as defined by ECGC) to total non-India exposures. |
|
|
4. |
Deterioration in Asset Quality |
|
|
|
(a) Ratio of gross NPAs + write offs during the year + restructured standard advances during the year to the gross advances at the beginning of the year. |
|
|
|
(b) Ratio of fresh slippage to actual recoveries during the year Up-gradation should not be considered |
|
|
|
(c) Ratio of provision plus write offs during the year to total income from advances and investments |
|
|
|
(d) Three year weighted average of fresh slippage to outstanding standard advances at the beginning of the year.
(Weights in proportion to outstanding standard advances at the beginning of the year) |
|
|
|
(e) Three year weighted average ratio of slippage of sub standard assets to doubtful to outstanding sub standard assets at the beginning of the year. |
|
|
|
(f) Net NPA to net advances ratio
We may decide to keep one of the two parameters (PCR or net NPA) after back testing. |
|
|
|
(g) Quick Mortality to amount disbursed during the year – separate ratios for retail and corporate (Quick Mortality |
|
|
|
(a) retail - slippage within 12 months from date of first disbursement , and |
|
|
|
(b) corporate - slippage within 24 months from date of first disbursement |
|
|
|
(h) Trend of three year rolling average over the previous three years, of slippages in restructured accounts as a percentage to total standard restructured accounts during the respective years. |
|
|
|
(i) Under provisioning in nonperforming assets to total provision required for non performing assets
(Assets: Advances, Investments and Other Assets) |
|
|
Credit Risk - Controls |
Sr. No. |
Elements |
Norms |
Score |
(a) |
Adequacy of risk management architecture |
|
|
(b) |
Adequacy of loan policy, restructuring policy, recovery policy, collateral management policy |
|
|
(c) |
Adherence to laid down policies including adherence to suitability and appropriateness policy for derivatives |
|
|
|
– Extent of deviation (Quantum of loans originated in the retail segment with de-
viations from internal norms/ceilings. PIO to also keep watch on the quantum of
NPAs emanating from loans sanctioned with such deviations). |
|
|
|
– Extent of deviation from policies and regulatory norms maybe considered in non
retail pre sanction appraisals. |
|
|
(d) |
Counterparty bank risk |
|
|
|
(i) System of review and monitoring of limits |
|
|
|
(ii) Basis / Rationale for setting up of limits and whether the same is documented in
a transparent manner |
|
|
|
(iii) Breaches in limits fixed (PIO to check if limits have been increased during the year
in the form of accommodative actions) |
|
|
(e) |
Delegation of Powers (DoP) – whether the DoP is clearly laid out and communicated, whether DoP is used or not (i.e. whether all proposals are being pushed to the higher committees), whether reporting is being done at required periodicity. |
|
|
(f) |
Post disbursement supervision – documentation review/renewal, verification of collat-erals, adequacy of insurance cover, creation of charge, unit visits, monitoring of draw-ing power, End use of funds – processes in place to ensure end use of funds and adher-ence to the same, monitoring of problem credits, monitoring of large credit exposures, adequacy of loan review mechanism, review of off-balance sheet exposures, etc. |
|
|
(g) |
Adequacy of risk rating framework and usage in bank including pricing |
|
|
(h) |
Processes in place for minimising risk arising out of country exposures including secu-rities taken, legal documentation, registration of charges in overseas territories, taking into account history of customers and experience with countries dealt with, controls in terms of tenure of exposures, etc. |
|
|
(i) |
(i) NPA divergence by AFI, Statutory auditors and overseas regulators to gross NPA as per bank |
|
|
|
(ii) NPI divergence by AFI, Statutory auditors and overseas regulators to gross NPI as per bank |
|
|
(j) |
Stress Testing – Whether events and scenarios as also their combinations have been taken in accordance with RBI guidelines on stress testing. Extent of deviation. |
|
|
(k) |
Preparedness towards implementation of advanced approaches. |
|
|
Note - The impact of Credit Derivative Swaps (CDS) should be taken into account while determining the adherence
to limits, efficacy of documentation, delegation of power (system and usage), formulation and adherence to policies,
concentrations, etc. |
ANNEX B
Market Risk
Inherent Risk
Sr. No. |
Elements |
Comments |
Maximum Score |
1. |
Size, Nature and Complexity of Investment portfolio |
|
|
|
(i) % of capital charge for market risk over the total capital |
|
|
|
(ii) % increase in the capital charge for market risk in comparison with the previous year |
|
|
|
(iii) Impairment in the value of AFS + HFT category for 200 basis point shock. (As a % of capital) |
|
|
|
(iv) Depreciation in the value of investments held under trading book – AFS+HFT portfolio |
|
|
|
(v) Investments out of restructured loans |
|
|
|
(vi) Likely impact on the value of HTM portfolio for 2% shock- Potential |
|
|
|
(vii) Derivatives as a % to total risk assets of the bank (credit equivalent) (Higher the %, higher is the risk) |
|
|
|
(viii) No. of breaches of all trading (including derivative) risk limits |
|
|
|
(ix) Likely impact of one percentage change in interest rate (100*PV01) only in trading portfolio - negative impact |
|
|
|
(x) Information ratio of the portfolio |
|
|
2. |
Forex risk |
|
|
|
(i) NOOPL as a % of total assessed capital fund |
|
|
|
(ii) % utilisation of NOOPL |
|
|
|
(iii) % utilisation of AGL |
|
|
Market Risk - Controls |
|
Major Components and Elements for assessment |
|
Maximum Score |
a) |
Adequacy of market risk management architecture
(Equity Risk Management, process to identify/ measure/ manage Foreign Exchange Risk, control systems designed to provide timely, accurate and informative MIS, evaluation of Front Office, Mid Office and back Office functions etc. may also be seen) |
|
|
b) |
System in place to monitor regulatory guidelines relating to Valuation, classification, sale and shifting from HTM category and necessary reporting thereof |
|
|
c) |
Whether aggregate risk limits / position limits cover all major trading positions |
|
|
d) |
Whether risk limits / trading limits have been validated through back testing and the validation periodically updated |
|
|
e) |
Whether stop-loss / take profit targets on trading positions generally adhered to? |
|
|
f) |
Net PV01 of securities transferred to HTM as a % aggregate AFS PV01 [ negative / small number means more interest rate sensitive securities have been transferred to AFS implying active PV01 reflecting higher proportion of aggregate interest rate risk and hence better risk control] |
|
|
g) |
Is the management of ALM and proprietary trading completely segregated ? Is the management of AFS portfolio distinctly bifurcated between ALM and proprietary trading ? |
|
|
h) |
Profit on sale of HTM securities as a % of aggregate trading profits [higher the ratio more the dependence on banking book for profit implying poorer profit planning] |
|
|
i) |
Are inter-bank, customer and liability related cash and derivative transactions subjected to price-scan ? |
|
|
j) |
Are intra day trading positions oversight by mid-office commensurate to the risk being run ? |
|
|
k) |
Are trading position defeasance period / individual trades being independently overseen / analysed by mid office for unusual trading practices ? |
|
|
l) |
Presence of scientific and market related TPM |
|
|
Interest Rate Risk in the Banking Book
Inherent Risk |
|
Inherent Risk- IRR indicators |
Maximum Score |
|
Total marks |
|
a) |
Earnings perspective: % decline in the NII due to standardised shock of 200 bps over 12 month horizon |
|
b) |
Economic value perspective - % of decline in the capital funds due to standardised shock of 200 bps |
|
c) |
Contribution of profit on HTM asset sales as a % of aggregate profit before tax |
|
d) |
% of change in the NII as compared to previous year |
|
|
Interest Rate Risk in the Banking Book - Controls |
|
a) |
Whether comprehensive policies including responsibilities, accountabilities, desired limits/ positions consistent with the strategic directions and risk tolerance levels/appetite are in place and properly communicated to all concerns? |
|
b) |
Does the bank have an effective transfer pricing mechanism linking liability pricing to that of assets |
|
c) |
Is the Base rate computation documented and the adherence to the laid down policy appropriate? |
|
d) |
Are the base rate reviews co-terminus with review of pricing of liability term structure? |
|
e) |
Adequacy of stress testing methodologies in risk analysis, risk management, limit setting and provision of capital and effectiveness thereof |
|
f) |
Whether control systems are designed to provide timely, accurate and informative MIS. |
|
ANNEX C
Operational Risk
Inherent Risk Elements |
|
Components/ Elements |
Norms |
Risk Scores |
1. |
People Risk |
|
|
|
i) Competence of people in different levels, job rotation, availability of job cards/ delegation of power and second level control /validation points, extent of mis-selling of products. |
|
|
|
ii) Movement in attrition levels particularly in critical areas like Treasury during last three years |
|
|
2. |
Process Risk |
|
|
|
a. House keeping |
|
|
|
i) Overall pendency, age of unreconciled items in inter-bank, transit, Nostro, Vostro accounts and clearing differences as well as implementation levels on adherence to extant instructions/strategies. |
|
|
|
ii) Movement of unreconciled items during past three years |
|
|
|
B. Fraud, vigilance and accountability |
|
|
|
i) Incidence of frauds in the bank |
|
|
|
ii) Trend in movement of frauds in the last three years in terms of number and quantum |
|
|
|
iii) Staff related frauds – number, nature and whether fraud due to failure of people / processes |
|
|
|
iv) Adherence to KYC/AML norms |
|
|
|
v) Adherence to policy on staff accountability |
|
|
|
c. Customer Service and complaint Redressal mechanism |
|
|
|
i) Trend in number and nature of complaints (including the outsourced areas) besides Banking Ombudsman awards during the last three years. |
|
|
|
ii) Quality of information on bank’s website, customer information about products offered, display of information at branches mandated by regulator as well as bank’s own policy |
|
|
3. |
Technology risk |
|
|
|
i) Effectiveness of IT systems
• extent of computerization / Core Banking Solutions.
• compatibility of IT systems with business model of the bank and scalability
to future strategies.
• data warehousing capability (system for purged data)
• ability to interface between different applications and generate MIS without
manual intervention and appropriate validations
• capability for NPA identification
• Extent of cyber frauds, phising attacks)
• History of operational break downs
(Systems down time, ATM down time, Programming error, etc) |
|
|
|
ii) Adherence to regulatory instructions/ bank’s policy with regard to Business Continuity Plan (BCP)/Disaster Recovery System (DRS) |
|
|
4. |
Compliance Risk |
|
|
|
A. compliance to various reporting requirements |
|
|
|
i) Accuracy, timeliness, integrity and reliability of Management Information System (MIS) with regard to Internal, Regulatory reporting and balance sheet disclosure. |
|
|
|
ii) Quality of internal returns, their usage and follow-up |
|
|
|
B. Timely and effective compliance to various regulatory guidelines/instructions, audit and inspection observations |
|
|
|
i) Regulatory compliance (status of AFI compliance /show cause notices/ penalties) |
|
|
|
ii) Compliance (Others) (SEBI, IT,other regulators, overseas Regulators) |
|
|
|
iii) Compliance to various audits of the bank viz, LFAR, Internal Audit, IS audit |
|
|
5. |
Legal risk |
|
|
|
Level of compliance to accounting standards with regard to claims against the bank not acknowledged as debt (CND), decrees passed against the bank, incomplete/defective documentation, quality of SLAs on outsourcing etc. |
|
|
6. |
Outsourcing risk |
|
|
|
• Adherence to the extant regulatory guidelines and bank’s internal policy
• Extent and criticality of the outsourced activities |
|
|
Operational Risk - Controls |
|
Components/ Elements |
Norms |
Risk Scores |
1. |
People Risk |
|
|
|
Policy for training/orientation programmes, recruitment process/procedures etc. Adequacy of vigilance mechanism in place for taking corrective action including removal of systemic deficiencies, examination of staff accountability, appropriate leave policy and compensation structure especially for dealers to deter mis-selling, excessive risk taking tendencies etc. |
|
|
2. |
Controls for process Risk |
|
|
|
A. House Keeping |
|
|
|
i) Systems and procedures /policies in place for reconciliation of inter-branch, transit accounts, suspense/sundry, Nostro/Vostro accounts, |
|
|
|
ii) Existence of maker-checker concept, strong exceptional reporting etc. as well as well defined accounting policy based on regulatory instructions and accounting standards |
|
|
|
B. Fraud, vigilance and accountability |
|
|
|
i) Systems / Procedures in place especially in sensitive areas/aspects for deterring fraud, prevention of recurrence , staff involvement etc. |
|
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ii) Robustness of KYC/AML policy, procedures etc. in place, system to enforce the same viz, in built checks and balances to freeze transactions /accounts in case of non-compliance the guidelines, periodical reviews, etc |
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C. Customer Service and Complaint Redressal |
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System in place for complaint/grievance redressal with well documented procedures and its dissemination among staff. System to include treatment of complaints by ‘whistle blower’. Also proper systems to ensure customer confidentiality. |
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3. |
General Controls for Technology Risk |
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i) Systems/Procedures laid down for back up, BCP, Disaster recovery and validation process. |
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ii) Controls in place for preventing phishing attacks as well as hacking of net banking site including incidence of cyber frauds by frequent reviews, enhancement of security features, etc |
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iii) Controls in place to restrict and monitor the direct access/modification of data where manual intervention is required |
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iv) IT training and awareness of applications to all Support Groups, which is reviewed at prescribed intervals. |
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4. |
Compliance Risk |
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A. Controls for Management Information Systems |
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i) System in place for ensuring reporting requirements. |
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ii) Well documented/robust calendar of returns, in tune with extant instructions and appropriate systems in place for reporting lines in respect of Exceptional Statements |
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B. Controls for Inspection, Audit (Statutory, concurrent etc.) including RBIA besides system to ensure Quality of compliance and closure of inspection reports |
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i) System in place for ensuring quality of compliance to AFI and other audit observations including the active involvement of ACB in ensuring the same. |
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ii) System in place for ensuring full coverage, submission of LFAR, MOC, finalization of accounts etc. by Statutory Auditors. |
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iii) System in place for ensuring scope, quality and coverage of various internal audits viz, internal inspection, concurrent audit, special audit, etc.; and period review of the audit function of the bank. |
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5. |
Legal risk covering claims, decree (against the bank) |
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i) System in place for ensuring proper documentation, insurance, SLAs while outsourcing, handling of tax disputes/aspects by legal professionals, obtention of legal opinion in case of CNDs etc. |
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6. |
Effectiveness of Operational Risk Management architecture and its oversight |
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i) Independence and integrity of risk management function |
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ii) Effectiveness of identification of all significant risks |
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iii) Quality of assessment/ measurement of risks |
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iv) Effectiveness in monitoring the level of risks |
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v) Extent of use of the risk management systems for business strategy/ decisions |
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ANNEX D
Liquidity Risk
Inherent Risk Elements
Sr. No. |
Components/ Elements |
Norms |
Risk Scores |
(A) |
LIQUIDITY RISK INDICATORS – STOCK APPROACH
(CARE - FORTNIGHTLY /MONTHLY AVERAGES TO BE TAKEN FOR CALCULATION OF ALL RATIOS) |
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1. (Volatile Liabilities - Temporary Assets) / (Earning Assets - Temporary Assets)
Measures the extent to which hot money supports bank’s basic earning assets. Since the numerator represents short-term, interest sensitive funds, a high and positive number implies some risk of illiquidity. |
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2. Core deposits / Total Assets
Measures the extent to which assets are funded through stable deposit base |
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3. (Loans + mandatory SLR + mandatory CRR + Fixed Assets)/Total Assets
Loans including mandatory cash reserves and statutory liquidity investments are least liquid and hence a high ratio signifies the degree of ‘illiquidity’ embedded in the balance sheet. |
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4. (Loans + mandatory SLR + mandatory CRR + Fixed Assets) / Core Deposits
Measure the extent to which illiquid assets are financed out of core deposits. Greater than 1 (purchased liquidity). Less than 1 (stored liquidity) |
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5. Temporary Assets/Total Assets
Measures the extent of available liquid assets. A higher ratio could impinge on the asset utilisation of banking system in terms of opportunity cost of holding liquidity |
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6. Temporary Assets/Volatile Liabilities
Measures the cover of liquid investments relative to volatile liabilities. A ratio of less than 1 indicates the possibility of a liquidity problem. |
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7. Volatile liabilities / Total Assets
Measures the extent to which volatile liabilities fund the balance sheet |
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8. Ratio of top depositors to total deposits
• 20 top depositors for deposit size up to 25000 crore
• 50 top depositors for deposit size up to 50000 crore
• 100 top depositors for deposit size up to 75000 crore
• 200 top depositors for deposit size up to 1 lakh crore or more |
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9. Net Stable Funding Ratio – {Available Stable Funding (ASF) / Required Stable Funding (RSF) } *100 > 100% |
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10. liquidity coverage Ratio (LCR)
(Stock of high quality liquid assets / Total net cash outflows over the next 30 calendar days) *100 ≥ 100% |
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B |
COMPLIANCE TO VARIOUS LIMITS FOR LIQUIDITY MANAGEMENT |
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11. Trend of compliance with ALM Guidelines of RBI – adherence to RBI norms in regard to first four buckets under structural liquidity statement |
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12. Trend of compliance with Internal limits on maturity mismatches set by the management |
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13. Trend of compliance with CRR/ SLR requirements |
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14. Trend of compliance vis-à-vis bank’s internal policy – including various ratios, liquidity/borrowing policies, targeted liquidity level, liquidity risk tolerance, deposit concentration, etc. |
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15. Trend to manage intraday liquidity positions and risks to meet payment and settlement obligations on a timely basis under both normal and stressed conditions |
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16. Foreign currency liquidity risk as monitored through MAP statements - compliance with AD (MA Series) Circulars |
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Volatile Liabilities: (Deposits + borrowings and bills payable upto 1 year). Letters of credit – full outstanding
Component-wise Credit Conversion Factor of other contingent credit and commitments Swap funds (buy/ sell) upto
one year. Current deposits (CA) and Savings deposits (SA) i.e. (CASA) deposits reported by the banks as payable within
one year (as reported in structural liquidity statement) are included under volatile liabilities. Borrowings include
from RBI, call, other institutions and refinance.
Temporary assets = Cash + Excess CRR balances with RBI + Balances with banks + Bills purchased
discounted upto 1 year + Investments upto one year + Swap funds (sell/ buy) upto one year.
Earning Assets = Total assets – (Fixed assets + Balances in current accounts with other banks + Other assets
excluding leasing + Intangible assets)
Core deposits = All deposits (including CASA) above 1 year + net worth
Assessment of Liquidity Risk
Risk Control |
Sr. No. |
Components/ Elements |
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1. |
Adequacy of liquidity risk management policy including articulation of tolerance limit and Funding strategies - (Care – not to be linked to market liquidity risk i.e. liquidity risks due to market disruptions or inadequate market depth) – It should provide effective diversification in the source and tenor of funding. Over -dependence on specific funding sources, say a particular market segment, if it is followed as a business model, may also be examined. |
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2. |
Efficacy of short-term Dynamic Liquidity monitoring mechanism (including intra-day liquidity positions) |
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3. |
Quality of ALM MIS in terms of information availability, accuracy, adequacy and integrity |
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4. |
Level of Top Management’s involvement in ALM |
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5. |
Analysis of behavioral maturity profile of various components of on / off-balance sheet items on the basis of assumptions and trend analysis supported by time series analysis |
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6. |
Tracking the impact of embedded options and to realistically estimate the risk profiles in their balance sheet. Any strategy in place to manage the situation arising out of exercise of embedded options |
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7. |
Backtesting - Frequency of variance analysis for validating/ fine-tuning the assumptions |
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8. |
Frequency of simulated studies on liquidity risk management and its impact on balance sheet due to various possible changes in market conditions – Both institution specific and market wide stress scenarios. |
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9. |
Contingency funding plans (CFP) to overcome such situations and frequency of reviews on CFP - evaluation thereof – Whether CFPs were linked to stress test results, clearly sets out the strategies for addressing liquidity shortfalls in emergency situations. Also, the liquidity line commitments available may be evaluated. |
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10. |
Use of sophisticated software / models used for liquidity management - Evaluation in terms of |
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• assumptions in the model are made known to ALCO and ALM Support Groups. |
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• assumptions are reviewed at least once a year. |
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• model is able to capture all the on-balance sheet and off-balance sheet items. |
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11. |
ALM support groups (for analyzing, monitoring and reporting the risk profile of the bank and preparing simulated studies forecasting the effects of various possible changes in market conditions related to balance sheet and recommending action needed to adhere to bank’s internal limits) |
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12. |
Oversight of Board/ MCB/ ALCO
Quality of oversight on liquidity management function
Frequency/ timeliness of review/ monitoring of liquidity management policies
Understanding of liquidity risk management (policies/ risks/ limits) by the senior management |
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ANNEX E
Governance and Oversight |
Sr. No. |
Elements |
Norms |
Risk Scores |
1. |
Corporate Governance |
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a) Compliance with regulatory guidelines on corporate governance |
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b) Professionalism in the Board
(qualification and experience of directors, capacity to avoid dominance of one or two directors, system of forwarding agenda papers and recording of minutes, effective monitoring of implementation of board-directions) |
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c) Quality of deliberations
Comprehensiveness and adequacy of reviews and quality of directions |
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d) Adequacy of the Board’s role in the formulation of policies on (i) business strategy, (ii) HR strategy including succession planning, (iii) strategy for technology, (iv) long term strategic planning. |
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e) Adherence to above policies / strategies by the Board (delegation of powers may be looked into in detail). |
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f) Strategy for pricing of products and services - Both assets and liabilities |
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g) Review of audit and compliance function |
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h) Overall risk management function and its evaluation (including group risk) |
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i) Effectiveness of Board Committees |
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2 |
Oversight |
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a) Ability and effectiveness of top management to implement Board’s strategy |
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b) Leadership, integrity, accountability |
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c) Assessment of HO control over branches |
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d) Compliance culture |
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