## _cr13267 ## Source details **Canonical URL:** [_cr13267](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr13267.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr13267.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr13267.pdf.json) --- ### A. Summary — overall findings - RBI commended for: higher than minimum capital requirements; frequent hands-on and comprehensive onsite inspections; conservative liquidity risk policy; restrictions on banks’ capacity to take on more volatile exposures. - Indian banking system remained largely stable during the global financial crisis. - Post-crisis measures: establishment of a Financial Stability and Development Council (FSDC); implementation of a countercyclical provisioning regime; development of a roadmap for introduction of a holding company structure. - Significant implementation gaps and constraints: - International supervisory information sharing and cooperation (largest gap). - Domestic supervisory information sharing and cooperation (to a lesser extent). - Weaknesses in financial architecture related to RBI legal independence and conflicts of interest when supervising state-owned banks. - Opportunities to better align supervisory policies/procedures with international best practice, including: - Improved coordination between central office and regional offices. - Increased interaction with auditors and private sector banks. - More focused attention to banks’ internal risk-management models. - Gradual move to more risk-based supervision. - Revision of RBI rotation policy to foster stronger supervisory expertise. ### A. Summary — specific supervisory and cross‑border issues - Overseas operations and home-host gaps: - Indian banks have established operations in more than 45 jurisdictions. - RBI has Memoranda of Understanding (MOUs) with only 2 jurisdictions; limited informal arrangements with several others. - Material gaps exist in supervisory information flow. - RBI has conducted no overseas inspections since 2008. - Licensing process does not systematically analyze host-country supervision quality nor consistently review whether home countries of foreign banks seeking to open offices in India practice consolidated supervision. - Best practice recommendation: establish and host supervisory colleges for internationally active Indian banks. - Consolidated supervision: - Authorities identified 12 financial conglomerates subject to a supplementary monitoring framework. - RBI cannot order inspections of subsidiaries it does not regulate, cannot carry out transaction testing at such subsidiaries, and cannot obtain inspection reports directly from their regulators (current practice: obtain reports from parent bank at time of inspection). - Proposed amendment to the BR Act (new Section 29 (A)) would, if enacted, address this deficiency. - Immediate recommendation: seek ways to receive inspection reports directly from peer supervisory agencies to reduce delays. - Suggested measures: limit participation at segments of interagency meetings to regulators only; reconsider methodology for rating banking companies to explicitly provide for contagion risk from nonbanking subsidiaries. ### A. Summary — legal independence and state‑owned bank supervision - Legal constraints on RBI independence: - Some provisions in the RBI Act and the BR Act allow the central government to give directions to RBI, require it to perform an inspection, overrule its decisions, and supersede the Central Board of RBI. - Removal of these provisions would provide greater legal certainty regarding RBI independence. - The law does not specify reasons for removal of the head of the supervisory agency during his/her term. - Supervision of state‑owned banks: - RBI still has an employee acting as a nominee director on each state-owned bank Board; this person is a current RBI employee from a department other than bank supervision and often takes an active role, blurring lines between supervision and bank management. - RBI’s remedial powers over public banks are more limited: statutes do not empower RBI to disempower public banks from carrying on banking business; RBI cannot remove officers/directors of a public bank, except directors appointed by shareholders other than the central government. - Prompt Corrective Action (PCA) regime includes considerable discretion; a 3 percent total capital level could involve very little (common) equity, allowing a bank potentially to operate for in excess of a year with extremely low capital. ### A. Summary — internal organization and supervisory approach - Regional structure and coordination: - RBI has a large number of regional offices each supervising assigned banking populations, producing coordination challenges. - Off-site monitoring is largely separated from on-site supervision. - Recommendation: establish a regular forum for inspectors to review findings, insights, and questions to strengthen supervisory judgments and develop a broader horizontal perspective. - Increase focus in the annual financial inspection (AFI) on critically assessing risk-management practices, including people quantity and skill levels in risk management and control functions. - Basel II and risk-modeling readiness: - Banks increasing risk-management sophistication; RBI announced timetable for implementation of the Basel II advanced approaches. - Comprehensive supervisory guidance for assessment of the Internal Capital Adequacy Assessment Process (ICAAP) was developed and banks have submitted ICAAPs. - Migration challenges to Basel II advanced approaches: constraints on data, tools, methodologies, skills for quantification and modeling of risks, and model validation. - Recommendations: address practical implementation issues consistently; consider formal regulatory requirement for banks to develop and implement a sound model validation policy and a system of periodic validation and independent testing by RBI examiners. ### A. Summary — RBI initiatives and staffing - Law and information‑sharing initiatives: - Proposed changes in banking law to provide RBI access to information from banking companies about associated enterprises (including nonbank financial companies) and to give RBI ability to order inspections of nonbank subsidiaries of banking companies. - Movement toward more MOUs to improve home/host coordination. - Initial steps toward more risk-based supervision; assessors recommend phased implementation integrating forward-looking elements and focusing beyond rectification of onsite deficiencies. - Special supervisory program for largest banking groups: - Steering group led by a deputy governor began a year-long review in April 2011. - Department of Banking Supervision (DBS) announced restructuring to move off-site monitoring closer to on-site inspection. - Oral advice (no documentation seen by assessors) that DBS will establish a new supervisory regime for the largest 12 banking companies designated as systemically important, including: - move supervisory responsibility from regional offices to central office; - shift from once-a-year inspections to a more continuous supervisory approach with targeted reviews. - Human resources and rotation policy: - Recommendation to review RBI rotation policy limiting build-up of supervisory expertise. - Suggest phased revision: narrow rotation areas to similar expertise (e.g., DBS, DBOD, and other departments involved in NBFI supervision). - To address regulatory capture concerns, implement rotations of supervisors assigned to specific supervised entities. - Staffing data: as of 2011, 645 people work in the Department of Banking Supervision (from 729 two years ago). - Institutional coordination: - With RBI representation on G-20, FSB, and Basel Committee, recommendation to adopt structural changes within RBI to better prepare representatives through improved coordination and focus between Departments. ### B. Information and methodology used for the assessment - Assessment part of joint IMF-World Bank Financial Sector Assessment Program (FSAP). - Assessment period: conducted from June 15 till July 1, 2011; reflects banking supervision practices of RBI as of the end of May 2011; covers only commercial banks. - Sources included RBI self-assessments (2011 and 2009), interviews with RBI staff, review of laws/regulations, on-site and off-site examination reports, meetings with Ministry of Finance, banks, external auditor, and banking association. - Assessment methodology: per Core Principles (CPs) Methodology (Basel Committee, October 2006); compliance assessed against “essential” and “additional” criteria with ratings based on essential criteria only. ### Institutional and macroprudential setting; market structure overview (selected statistics) - GDP growth: India recovered strongly—GDP grew by 8¼ percent in 2010 and is forecast to grow at 7¾ percent in 2011. - Inflation: headline inflation above 8 percent annually since mid-2008. - Financial sector size: overall financial sector assets about 150 percent of GDP. - Commercial banks: comprise nearly 60 percent of total financial assets. - Mutual funds: invest 70 percent of assets in short-term instruments (bulk are bank certificates of deposits (CDs)). - Bank CDs issued to mutual funds: account for 8 percent of total deposits in 2011, up from 3 percent in 2007. - Public sector banks: account for nearly three-fourths of total banking assets; government’s share in capital of public sector banks close to the 51 percent statutory minimum. - Priority sector lending targets: 40 percent of total loans and advances for domestic banks and 32 percent for foreign banks. ### Preconditions and market infrastructure (selected findings) - Payment and settlement: PSS Act, 2007 provides legal basis; CPSS self-assessment finds existing payment system operates cheaply and efficiently with minimal systemic risk; suggested measures include shifting high-value transactions to RTGS and optimizing electronic payments. - Insolvency and debt recovery: governed by multiplicity of laws; DRT and SARFAESI (2002) have limitations—low returns and long liquidation times. - Accounting and auditing: ICAI sets accounting standards; RBI preparing prudential guidelines for alignment with international accounting standards by 2013; need greater IFRS awareness among auditors. - AML/CFT: PMLA 2002 core framework; regulators issued guidelines for CTR/STR; major areas needing improvement: effective implementation of record-keeping and robust STR submission regime. - Lender-of-last-resort: RBI has broad LoLR powers under sections 17 and 18 and has constituted a working group on liquidity to examine LoLR powers and instruments. - Deposit insurance: DICGC (wholly owned by RBI) provides deposit insurance covering all commercial banks including local area banks, regional rural banks, and urban cooperative banks. - Crisis governance: FSDC established in December 2010, chaired by the Union Finance Minister with an RBI‑chaired sub-committee expected to be a hands-on financial stability body. ### Prudential regulation — capital, model validation, and large exposures - Capital adequacy: - Master circular “Prudential guidelines on Capital Adequacy and Market Discipline” (MC) updated 1 July 2010. - Minimum Capital Adequacy Ratio: at least 9 percent of risk-weighted assets (Basel II methodology). - Minimum Tier 1 capital ratio: 6 percent. - System level capital ratio: stood at 14.5 percent per cent at the end of March 2011. - Around 85 percent of Tier 1 consisted of common equity at assessment time. - All banks on standardized approaches at assessment date; RBI published timetable for adoption of advanced approaches and will move to Basel III on internationally agreed timeline. - Recommendation: issue guidelines requiring adequate distribution of capital among different entities of the banking group. - Risk-model validation: - Finding: requirement needed for periodic and rigorous risk model review and validation by banks, even for models not used for regulatory capital. - Prudential guidance needs to be applied to the consolidated banking group rather than only the bank. - Large exposures and connected counterparties: - Current large exposure limit: maximum of 55 percent of a banking groups’ capital noted in summary (source notes group borrower limit of 40 percent which can exceptionally be brought to 50 percent for infrastructure, assessors note 55 percent elsewhere as characteristic of framework). - Assessors note group large exposure limit of 40 percent (exceptionally 50 percent for infrastructure) is significantly higher than the 25 percent considered good international practice. - Recommendation: strengthen definition and onsite verification of “connected exposures”; broaden guiding principles to include cross-guarantees or financial interdependency. - Related parties: - Finding: definitions of related parties and arm’s-length requirements require strengthening; current definition excludes shareholders and promoters. - Recommendation: remedy definition to include shareholders or promoters; consider regulatory approaches for excluding related-party lending from capital or other adjustments. - No formal legal/regulatory requirement to inform RBI immediately of adverse developments in operational risk; in practice quarterly meetings ensure RBI is informed within maximum three months after the facts. Recommendation: introduce formal immediate notification requirement. ### Supervisory methods, reporting, and corrective powers (selected) - Supervisory approach: - RBI uses extensive onsite inspections and offsite monitoring; emerging global practices being introduced. - Need for more structured interaction between in-house regulatory areas and field inspectors; reconsideration of rotation policies to develop specialized expertise. - Recommendation: perform more intensive reviewing of nonbank subsidiaries; improve monitoring of foreign operations via better information flow and overseas inspections. - Supervisory reporting: - Section 27(1) and (2) BR Act: banks submit monthly prudential returns; RBI may request any information from banking companies in the form and frequency it deems necessary. - Consolidated prudential returns collected on a 6 monthly basis. - RBI cannot require information from affiliated but unregulated entities; proposed statutory amendment (new Section 29 (A)) would allow RBI to call for information from any entity in the banking group. - Accounting and disclosure: - Financial statements based on ICAI accounting standards; convergence with IFRS scheduled from April 2013. - AS 30, 31 and 32 on financial instruments not notified and not binding. - RBI does not have access to external auditors’ working papers; recommended to increase interaction with external auditors. - Corrective and remedial powers: - RBI has broad discretion and a PCA regime with triggers tied to net NPA ratio, capital adequacy ratio and return on assets. - PCA mechanics (selected thresholds described in source): - CRAR falling below 9 percent: require capital augmentation plan, restrict expansion of Risk-weighted Assets, require dividends reduced/skipped. - CRAR falls to 6 percent: order recapitalization and may change directors or Management. - CRAR falls below 3 percent: steps to merge/amalgamate/liquidate or impose moratorium if CRAR does not improve beyond 3 percent within one year or such extended period as may be established. - Limitation: many remedial powers not generally applicable to public sector banks (public sector banks represent more than 70 percent of Indian banking market). ### Consolidated and cross‑border supervision — key grades and recommendations - CP 24 (Consolidated supervision): Assessment Largely Compliant. - Gaps: inability to order inspections of unregulated domestic subsidiaries; lack of direct receipt of inspection reports from nonbank supervisory agencies; need for more regular regulators-only interagency meetings; rating methodology should reflect nonbank subsidiary issues. - CP 25 (Home-host relationships): Grading Materially Noncompliant (MNC). - Key gaps: - Indian banks operate in more than 45 jurisdictions, but RBI has MOUs with only two and limited informal arrangements with few others. - RBI has not conducted overseas inspections since May 2008. - RBI has not hosted supervisory colleges. - Licensing does not consistently assess whether home countries of foreign applicants practice consolidated supervision. - Recommendations: accelerate MOUs and information-sharing mechanisms; consider hosting supervisory colleges; assess host/home supervisory quality more rigorously during licensing. ### Selected recommended action plan (high-level highlights) - CP 1: Remove impeding legal provisions; clarify role or abolish nominee director in public banks; specify legal reasons for removal of head of supervisory agency; enshrine protection for defense costs of supervisors; develop mechanisms for domestic written information sharing and regular semi-annual regulators-only meetings. - CP 3: Strengthen ex ante review of intended risk management and control systems for new banks; require foreign bank applicants to be subject to consolidated supervision in home country. - CP 6: Issue guidelines requiring adequate distribution of capital among group entities; address Basel II advanced model implementation challenges. - CP 7: Require periodic and rigorous model review and validation by banks and apply risk guidance to consolidated banking company. - CP 10: Strengthen criteria for connected exposures and lower group large exposure limits toward international practice. - CP 11: Include shareholders and promoters in definition of related parties; require loans to subsidiaries/joint ventures be on an arm’s-length basis. - CP 15: Require banks to inform RBI immediately of any adverse developments in operational risk. - CP 21: Introduce power to require information from affiliated but unregulated entities. - CP 22: Obtain access to external auditors’ working papers; increase interaction with auditors. - CP 23: Consider extending remedial powers applicability to public banks. - CP 24/25: Empower RBI to require inspections/reports from domestic subsidiaries it does not regulate; accelerate MOUs and consider hosting supervisory colleges; conduct more overseas inspections. ### RBI response — overview of positions and commitments - RBI welcomed the review as “extensive, comprehensive and productive” and noted assessment “with respect to the highest international standards.” - RBI recognizes “no room for complacency” and is “committed to adoption of international standards and best practices, wherever necessary, and in a phased manner and calibrated to local conditions.” - Key gaps acknowledged by RBI: international supervisory information sharing and cooperation; domestic supervisory information sharing and cooperation; consolidated supervision of financial conglomerates; some limits on de jure independence. - RBI reports ongoing/planned actions: - “Information sharing arrangements with four jurisdictions”; “MOUs with another 12 jurisdictions are expected to be reached shortly”; informal arrangements with major jurisdictions. - Efforts to establish supervisory colleges to increase efficacy of supervision. - Steps to supervise financial conglomerates: prudential limits on interbank liabilities, caps on lending/borrowing, restrictions on investments in capital instruments of other banks, stricter prudential regulation of NBFCs, restrict complex activities and intensify monitoring of common exposures. - Position on nominee directors: legislative amendments sought to avoid placing serving RBI officers on bank boards; serving officers replaced by retired officers historically; RBI has taken up amendments with Government of India. - RBI maintains regulations are ownership neutral and states it does not consult government when imposing penalties on public sector banks. *Source: IMF–World Bank FSAP assessment chapter "1. Summary of Compliance with the Basel Core Principles" (assessment conducted June 15–July 1, 2011; reflects practices as of end of May 2011).* ### 1. Summary of Compliance with the Basel Core Principles ................................................18 ### 1. Summary of Compliance with the Basel Core Principles ### A. Summary — overall findings - The Reserve Bank of India (RBI) is commended for a tightly controlled regulatory and supervisory regime composed of higher than minimum capital requirements, frequent hands-on and comprehensive onsite inspections, a conservative liquidity risk policy, and restrictions on banks’ capacity to take on more volatile exposures. - The Indian banking system remained largely stable during the global financial crisis. - Since the crisis, the government of India and RBI have taken additional measures, including establishment of a Financial Stability and Development Council (FSDC), implementation of a countercyclical provisioning regime, and development of a roadmap for introduction of a holding company structure. - Significant implementation gaps and constraints remain, notably: - International supervisory information sharing and cooperation (largest gap). - Domestic supervisory information sharing and cooperation (to a lesser extent). - Persisting weaknesses in financial architecture related to RBI independence and conflicts of interest when supervising state-owned banks. - Opportunities to better align supervisory policies and procedures with international best practice, including: - Improved coordination between central office and regional offices. - Increased interaction with auditors and private sector banks. - More focused attention to banks’ internal risk-management models. - Gradual move to more risk-based supervision. - Revision of RBI rotation policy to foster stronger supervisory expertise. ### A. Summary — specific supervisory and cross-border issues - Indian banks have established significant overseas operations in more than 45 jurisdictions, but: - RBI has Memoranda of Understanding (MOUs) with only 2 jurisdictions. - RBI has limited informal arrangements with several others. - There are material gaps in the flow of supervisory information. - RBI has conducted no overseas inspections since 2008. - It was not clear that the licensing process systematically analyzes host-country supervision quality or consistently reviews whether home countries of foreign banks seeking to open offices in India practice consolidated supervision. - As a home supervisor, best practice would include establishing and hosting supervisory colleges for internationally active Indian banks. - Consolidated supervision: - Authorities identified 12 financial conglomerates subject to a supplementary monitoring framework. - RBI cannot order inspections of subsidiaries it does not regulate, carry out transaction testing at such subsidiaries, or obtain inspection reports directly from their regulators (current practice is to obtain these reports from the parent bank at time of inspection). - A proposed amendment to the BR Act would, if enacted, address this deficiency. - Immediate recommendation: seek ways to receive inspection reports directly from peer supervisory agencies to reduce delays. - Other suggested measures: limit participation at segments of interagency meetings to regulators only; reconsider methodology for rating banking companies to explicitly provide for contagion risk from nonbanking subsidiaries. ### A. Summary — legal independence and state-owned bank supervision - No instances of de facto government interference were observed, but legal provisions in the RBI Act and the BR Act limit de jure independence: - Some provisions allow the central government to give directions to RBI, require it to perform an inspection, overrule its decisions, and supersede the Central Board of RBI. - Removal of these provisions would provide greater legal certainty regarding RBI independence. - The law does not specify reasons for removal of the head of the supervisory agency during his/her term. - Supervision of state-owned banks: - RBI still has an employee acting as a nominee director on each state-owned bank Board; in practice this is a current RBI employee from a department other than bank supervision. - This nominee director often takes an active role in Board discussions and is sometimes implicitly relied upon to ensure regulatory compliance, blurring lines between supervisory role and Board compliance guardian. - RBI’s remedial powers over public banks are more limited: statutes do not empower RBI to disempower public banks from carrying on banking business, and RBI cannot remove officers/directors of a public bank, except directors appointed by shareholders other than the central government. - Prompt Corrective Action (PCA) regime includes considerable discretion; a 3 percent total capital level could involve very little (common) equity, allowing a bank potentially to operate for in excess of a year with extremely low capital. ### A. Summary — internal organization and supervisory approach - RBI has a large number of regional offices each supervising assigned banking populations, producing coordination challenges: - Off-site monitoring is largely separated from on-site supervision. - Recommendation: establish a regular forum for inspectors to review findings, insights, and questions to strengthen supervisory judgments and develop a broader horizontal perspective. - Encourage increased focus in the annual financial inspection (AFI) on critically assessing risk-management practices, including assessment of people quantity and skill levels in risk management and control functions. - Basel II and risk-modeling readiness: - Indian banks are increasing risk-management sophistication; RBI has announced a timetable for implementation of the Basel II advanced approaches. - Comprehensive supervisory guidance for assessment of the Internal Capital Adequacy Assessment Process (ICAAP) was developed and banks have submitted their ICAAPs. - Challenges remain for migration to Basel II advanced approaches, mainly constraints on data, tools, methodologies, skills for quantification and modeling of risks, and model validation. - Recommendation: RBI consider how to address practical implementation issues consistently and whether supervisory policies/practices need strengthening for ongoing supervision of banks applying Basel II advanced models. - Increased supervisory attention is needed for risk models used for risk-management even if not used for regulatory capital; recommend a formal regulatory requirement for banks to develop and implement a sound model validation policy and a system of periodic validation and independent testing by RBI examiners. ### A. Summary — RBI initiatives and staffing - RBI action steps underway (as reported by assessors): - Proposed changes in banking law to provide RBI access to information from banking companies about associated enterprises (including nonbank financial companies) in a timely and certain basis, and to give RBI ability to order inspections of nonbank subsidiaries of banking companies. - Movement toward putting in place more MOUs to improve home/host coordination. - Initial steps toward more risk-based supervision; assessors recommend continuing a phased implementation by gradually integrating more forward-looking elements into supervision and focusing beyond rectification of onsite deficiencies. - Special supervisory program for largest banking groups: - RBI launched an initiative to consider modifications for supervisory process of largest banking groups: a steering group led by a deputy governor began a year-long review process in April 2011. - Department of Banking Supervision (DBS) announced restructuring to move off-site monitoring closer to on-site inspection. - Oral advice (no documentation seen by assessors) that DBS will establish a new supervisory regime for the largest 12 banking companies designated as systemically important, including: - moving supervisory responsibility from regional offices to central office; - shifting from once-a-year inspections to a more continuous supervisory approach with targeted reviews. - If well developed and implemented, the program could improve: risk-focus of supervision, linking monitoring and on-site inspections, consistency and effectiveness of supervision for systemically important firms, and development of specialized expertise needed for Basel II and Basel III. - Human resources and rotation policy: - Recommendation to review RBI rotation policy which limits build-up of supervisory expertise. - Suggest phased revision: narrow rotation areas to similar areas of expertise (e.g., limited to DBS, DBOD, and other departments involved in NBFI supervision). - To address regulatory capture concerns, implement rotations of supervisors assigned to specific supervised entities. - Institutional coordination: - With RBI representation on G-20, FSB, and Basel Committee, recommendation to adopt structural changes within RBI to better prepare representatives through improved coordination and focus between Departments. ### B. Information and Methodology Used for the Assessment - The assessment was conducted as part of the joint IMF-World Bank Financial Sector Assessment Program (FSAP). - The assessment was conducted from June 15 till July 1, 2011, and reflects banking supervision practices of RBI as of the end of May 2011; it covers only commercial banks. - Sources used included: - complete self-assessments prepared by RBI in 2011 and 2009; - detailed interviews with RBI staff at head office and the regional office in Delhi; - review of laws, regulations, and other documentation on supervisory framework and structure/development of Indian financial sector; - review of a number of on-site and off-site examination reports and correspondence with banking companies and auditors; - meetings with the Ministry of Finance, state-owned banks, private sector banks, foreign banks, an external auditor, and the banking association. - Assessment methodology: - Performed in accordance with the Core Principles (CPs) Methodology (Issued by the Basel Committee on Banking Supervision, October 2006). - Assessed compliance with both “essential” and “additional” criteria; ratings were based on compliance with the “essential” criteria only. - The assessment is based on legal and documentary evidence combined with supervisory work and its implementation in the banking sector. *Source: IMF–World Bank FSAP assessment chapter "1. Summary of Compliance with the Basel Core Principles" (assessment conducted June 15–July 1, 2011; reflects practices as of end of May 2011).* ### 17. This assessment is based solely on the laws, supervisory requirements, and ### _cr13267 - 17. This assessment is based solely on the laws, supervisory requirements, and ### Institutional and Macroprudential Setting; Market Structure Overview - India recovered strongly from the fallout from the global financial crisis: GDP grew by 8¼ percent in 2010 and is forecast to grow at 7¾ percent in 2011, driven by domestic demand. - Inflation has been a key concern, with headline inflation above 8 percent annually since mid-2008; real interest rates remain negative despite the RBI gradually lifting policy rates. - External flows and balance of payments: - Foreign direct investment and equity flows have fallen, reducing concerns about excessive inflows and rupee appreciation. - Recent strong export performance has helped contain the current account deficit. - A trend toward short-term capital inflows raises concerns about sustainability. - Risks going forward include high oil prices, inflation, and weaknesses in governance. - Financial sector composition and linkages: - Overall financial sector assets are about 150 percent of GDP. - Commercial banks comprise nearly 60 percent of total financial assets. - Mutual funds invest 70 percent of assets in short-term instruments, the bulk of which are bank certificates of deposits (CDs). - Bank CDs issued to mutual funds account for 8 percent of total deposits in 2011, up from 3 percent in 2007. - NBFCs borrow from banks and mutual funds; banks invest in, and borrow from, mutual funds. - Industrial companies are not allowed to own banks; authorities are considering new norms for bank licensing and a holding company structure to permit mixed conglomerates. - Public sector banking and government role: - Majority government-owned banks account for nearly three-fourths of total banking assets. - The government’s share in the capital of public sector banks is now close to the 51 percent statutory minimum. - A sizable portion of banking assets is held in government securities under a 24 percent minimum statutory liquidity requirement. - Lending targets to priority sectors: 40 percent of total loans and advances for domestic banks and 32 percent for foreign banks. - Lending to infrastructure and real estate has grown rapidly; infrastructure lending has been actively promoted, including through relaxation of prudential standards. - Financial inclusion and institutional framework: - Measures to promote access include ‘no frills’ accounts; simplified know-your-customer rules for small accounts; incentives for branches in under-served areas; business correspondent/agent models; and mobile phone banking. - Institutional framework includes rural cooperative banks; regional rural banks sponsored jointly by public sector banks and the government; and development finance institutions such as NABARD and SIDBI. - Regulatory architecture: - RBI regulates banks and some NBFCs. - IRDA regulates insurance. - SEBI regulates spot and derivatives markets of various financial instruments. - FMC regulates the commodity futures market. - PFRDA is meant to regulate the nascent pension fund industry, though its enabling legislation is yet to be approved. - NABARD is both a credit provider and a supervisor of cooperative banks (other than primary cooperative banks) and regional rural banks. - Jurisdictions are generally well demarcated, but gaps and overlaps remain. - The Financial Stability and Development Council (FSDC) has been established, comprising the financial regulators and chaired by the Union Finance Minister. ### Preconditions for Effective Banking Supervision - Payment and settlement systems: - RBI’s oversight provided by the Payment and Settlement Systems (PSS) Act, 2007 and the Payment and Settlement System Regulations. - The Act defines settlement finality and provides explicit legal basis for multilateral netting. - The 2009 CPSS Core Principles self-assessment finds the existing payment system operates cheaply and efficiently, with minimal systemic risk. - Suggested measures to strengthen payment and settlement systems include: - shifting high-value transactions to a more secure electronic payment system, like real time gross settlement system (RTGS); - combating credit card fraud; and - optimizing utilization of electronic payments infrastructure and reducing charges. - Insolvency and debt recovery: - Insolvency is governed by a multiplicity of laws; registering security interests remains difficult. - Primary creditor recovery tools: Debt Recovery Tribunals (DRT) and SARFAESI (2002), both with significant limitations—relatively low returns for creditors and long liquidation times. - Delays in recovery proceedings slow credit growth and reduce funds available for creditworthy borrowers. - Accounting and auditing standards: - ICAI sets accounting standards; RBI can require carve-outs or modifications for commercial banks (used for provisioning and disclosure). - RBI is preparing prudential guidelines for alignment of Indian accounting standards with international accounting standards by 2013. - Need for greater awareness of IFRSs among auditors and other stakeholders, and systems/procedures to comply with IFRS. - India adopted International Standards on Auditing early, but proactive implementation steps are needed: - issue more technical guidance to help small and medium practitioners; - operationalize the Quality Review Board and accelerate making the Board of Discipline and Disciplinary Committee functional; - allow principal auditors access to auditors’ working papers; and - grant functional independence to the Auditing and Assurance Standards Board (AASB). - AML/CFT framework: - Prevention of Money Laundering Act (PMLA) 2002 provides the legislative framework. - Regulators have issued guidelines for CTR/STR submission to the FIU, record preservation, and wire transfer guidance. - Major areas needing improvement: effective implementation of record-keeping requirements and a robust regime for submission of STRs. - Market discipline and disclosures: - Listed companies face a modern continuous disclosure regime; banks have specific disclosure requirements including publication of annual reports and audit financial statements. - RBI prescribes key disclosure elements, including governance and risk-management arrangements. - Need to strengthen disclosure mechanisms for greater transparency in ownership structures and impose stringent penalties for nontransparent practices. - Implementation of IFRS is expected to reinforce effective market discipline. - Systemic protection and crisis arrangements: - RBI has broad lender-of-last-resort (LoLR) powers under sections 17 and 18 of the RBI Act (‘war-time’ powers) and a variety of instruments to meet crisis situations. - RBI has constituted a working group on liquidity with mandate to examine: - (i) the powers available to RBI regarding its role as LoLR; - (ii) scope for a mechanism to activate support at the shortest possible notice; and - (iii) scope for expanding permissible liquidity instruments. - RBI does not encourage ex-ante assurance of emergency support to avoid moral hazard; interventions depend on circumstances and judgment about contagion and systemic stability. - Existing instruments are considered adequate; RBI retains choice of conventional and unconventional measures. - Deposit insurance: DICGC (a wholly owned subsidiary of RBI) provides deposit insurance covering all commercial banks, including local area banks, regional rural banks, and urban cooperative banks in all states and union territories (UTs). - Governance for domestic crisis management: - FSDC established in December 2010, to be chaired by the Union Finance Minister, assisted by a sub-committee chaired by the RBI governor. - FSDC provides broad oversight; the sub-committee is expected to be a hands-on financial stability body in normal times. - Remaining needs: establish contingency plans and action plans; extensive cross-sectoral cooperation to identify threats and test contingency plans; coordinated responses in crisis resolution. ### Main Findings (Selected) - Objectives, Independence, Powers, Transparency and Cooperation (CP 1): - RBI independence is not enshrined in law and some legal provisions could undermine independence (central government can give directions, overrule decisions, and supersede the RBI Board), though these provisions have not been used in practice. - RBI lacks explicit legal power to disempower a public bank to carry on banking activities. - Removal grounds for the RBI governor are not specified; governor is appointed for a maximum term with possibility of reappointment. - In public sector banks, an RBI representative still acts as a Director on the Board; that person is a current RBI employee from a department other than banking supervision and sometimes takes an active role—this can blur supervisory and management roles and requires greater clarity on limitations. - Legal protection for supervisors exists and RBI bears employees’ costs of defending actions made in good faith; recommended enhancements include explicit statutory protection beyond termination and clear financing arrangements for defense costs from the start of proceedings. - RBI has MOUs with foreign supervisors approved by the central government but lacks extensive formal or informal supervisory information-sharing arrangements; absence of arrangements for supervisory information sharing should be addressed urgently given overseas activities of Indian banks. - RBI does not have direct access to call for information for any entity in the banking group; proposed amendment to Section 29A of the BR Act under the Banking Law Amendment Bill 2011 is expected to remedy this gap. - Licensing and Structure (CPs 2–5): - India has a sound framework for granting banking licenses and overseeing ownership changes and intended expansion. - Clear demarcation between bank and nonbanks and a well-defined set of permissible bank activities. - Improvement opportunities: controlling foreign bank entry and Indian bank expansion overseas; ensuring licensing processes require strong risk-management programs for new banks. - Prudential Regulation and Requirements (CPs 6–18): - RBI has set prudent minimum capital adequacy requirements and defined capital components in line with internationally agreed guidelines. - Major challenges remain for migration to Basel II advanced approaches, including constraints on data, tools, methodologies, and skills for risk quantification, modeling, and model validation. - RBI will need to address practical implementation issues consistently and enhance supervisory policies and practices for ongoing supervision of banks applying Basel II advanced models. *Source: _cr13267 - 17. This assessment is based solely on the laws, supervisory requirements, and* ### 41. The assessors identified several other areas for strengthening of prudential ### _cr13267 - 41. The assessors identified several other areas for strengthening of prudential ### Prudential regulation: model validation and group-level application - Finding: A requirement is needed for periodic and rigorous risk model review and validation by banks, even for risk models that are not used as input for regulatory capital purposes. - Finding: Prudential guidance needs to be issued to, and applied to, the consolidated banking group rather than just to the bank. ### Concentration limits and connected exposures - Finding: The prudential framework in India is characterized by concentration limits that are significantly higher than international best practice and by a too-general definition of connected counterparties. - Finding: The current large exposure limit is a maximum of 55 percent of a banking groups’ capital. - Recommendation: More guidance and more frequent and detailed onsite verification of the criteria for the determination of “connected exposures” is required. - Recommendation (example): Broadening guiding principles to include cross-guarantees between entities or financial interdependency that result in the entities becoming one single risk. - Assessment note: The large exposure limit of 40 percent—which can exceptionally be brought to 50 percent for infrastructure exposures—for a group borrower is significantly higher than the large exposure limits of 25 percent that is considered good international practice. ### Related parties, arm’s-length transactions, and operational risk reporting - Finding: Definitions of related parties and requirements for arm’s-length transactions require strengthening. - Recommendation: Remedy the failure of the definition of related parties to include shareholders or promoters. - Recommendation: Develop regulatory approaches for excluding lending to related parties from capital or taking other adjustment steps. - Finding: There is no formal legal or regulatory requirement to inform RBI immediately of any adverse developments in operational risk. - Practice note: In practice, quarterly meetings with banks ensure RBI is kept informed of material adverse operational risk developments within maximum three months after the facts. - Recommendation: Introduce a formal legal or regulatory requirement to inform RBI immediately of any adverse developments in operational risk. - Recommendation: Enhance internal control framework by ensuring updates on developments affecting the fit-and-proper test for existing directors are received, and strengthen the AFI process focus on the quantity and skill of people in risk management and control functions. ### Supervisory methods (CPs 19–21) - Finding: RBI supervises banks with a well-defined set of on-site supervisory practices, extensive regulatory reporting, and improving off-site monitoring techniques. - Finding: Emerging global practices are being introduced, but more structured interaction between in-house regulatory areas and field inspectors would enhance rigor and consistency. - Finding: RBI largely defers to functional supervisors of nonbank affiliates domestically, and to foreign supervisors of overseas offices and subsidiaries, although regulatory reports to RBI cover such operations. - Concern: Challenges exist in ensuring appropriately specialized supervisory expertise is developed and maintained, particularly given RBI-wide rotational policies. - Recommendation: Reconsider strict rotation policies; narrow rotation areas to similar areas of expertise (e.g., Department of Banking Supervision, Department of Banking Operations and Development, and other departments involved in supervision of NBFIs). - Recommendation: Implement rotations of supervisors assigned to specific supervised entities to address regulatory capture concerns. - Recommendation: Review staffing levels given future demands from Basel II and Basel III and movement to more continuous supervision. ### Accounting and disclosure (CP 22) - Finding: Room for improvement in frequency and intensity of interaction between RBI and external auditors and access rights to external auditors’ working papers. - Note: RBI does not have direct authority to rescind the appointment of the external auditor, but it can, and has in the past, withdrawn approval of the appointment. ### Corrective and remedial powers (CP 23) - Finding: RBI has broad discretion in remedial actions, a prompt corrective action regime, and tools for problem bank resolution for private sector banks. - Limitation: This architecture is not generally applicable in practice to public sector banks, which make up the largest percentage of the Indian banking market. - Data point: Public sector banks represent more than 70 percent of the Indian banking market. ### Consolidated and cross-border supervision (CPs 24–25) - Finding: RBI has begun efforts to improve focus on consolidated supervision and cross-border supervision, with more structured forums for interaction with domestic functional regulators and steps to improve coordination with foreign supervisors through MOUs. - Recommendation: Broaden supervisory focus domestically by changing practices for obtaining information from firms, using a more appropriate construct for evaluating consolidated firms, and interacting more effectively with functional regulators. - Recommendation: Proposed statutory amendment would improve consolidated information access by RBI. - Concern: Absence of formal, or even extensive informal, arrangements for receiving information from host supervisors is a serious problem given large and growing overseas activities of Indian banks in numerous foreign jurisdictions. - Recommendation: Accelerate process of entering into formal MOUs or other means; improve regular information flow from domestic nonbank supervisors. - Suggested mechanisms to improve cooperation: - Mechanisms for regular written material (including inspection reports) to be shared on a timely basis. - Broad and operational escalation protocols to promptly alert other relevant supervisors. - Semi-annual meetings on major banking companies to take place on a fully regular basis with opportunity for regulators-only discussion. ### Licensing, capital adequacy, and other supervisory findings (selected) - Licensing: RBI has a clear licensing process; areas to strengthen include closer ex ante review of intended risk management and control systems and requiring foreign bank applicants to be subject to overall consolidated supervision in home country. - Capital adequacy: RBI has set prudent minimum capital requirements and defined components of capital in accordance with internationally agreed guidelines; RBI’s requirements are stricter than applicable Basel requirements. - Transition: RBI will move to Basel III on the internationally agreed timeline. - Recommendation: RBI should issue guidelines requiring adequate distribution of capital among different entities of the banking group. - Risk management process: Areas of improvement include establishing a requirement for periodic and rigorous model review and validation by banks and ensuring risk guidance is applied to the consolidated banking company. - Credit risk: No explicit RBI requirement that major credit risk exposures exceeding a certain amount or percentage of capital be decided by senior management; no specific requirement that potential future exposure be included in credit management strategies or policies. - Recommendation: Consider requiring banks to have a comprehensive model validation policy approved by the Board, including for banks on the standardized approach that use internal models for pricing. - Operational risk implementation timeline: - RBI set up in 2010 a Working Group on Information Security, Electronic Banking, Technology Risk Management, and Cyber Frauds. - Banks were required to conduct a formal gap analysis and establish a time-bound action plan to address gaps. - Requirement: Banks need to ensure implementation of basic organizational framework and policies by October 31, 2011. - Requirement: The rest of the guidelines need to be implemented by April 2012, unless a longer timeframe is indicated in the circular. *Source: IMF assessment unit content.* ### 16. Interest rate ### 16. Interest rate ### Internal control and audit (CP 17) - RBI has put in place a good framework for internal controls; annual financial inspections evaluate internal audit governance, processes, sanctions authorities, and compliance approach and effectiveness. - Areas for improvement: - Ensuring updates on developments affecting the fit and proper test for existing directors are received. - Ensuring a strong focus in the annual financial inspection process on assessing the quantity and skill level of people in risk management and control functions. ### Abuse of financial services / AML/CFT (CP 18) - The issues raised in FATF Mutual Assessment Report on AML/CFT that were within the responsibility of RBI have been addressed. - RBI regulatory framework for AML generally complies with the essential criteria of this Core Principle. - Inspection reports reviewed by the assessors mentioned many critical weaknesses in the areas of AML/Know your Customer. - Know your Customer/AML inspections have only started recently and hence no full level of compliance is to be expected at this stage. ### Supervisory approach (CP 19) - RBI uses extensive onsite inspections and offsite monitoring of financial returns to track risk profiles. - Staffing and expertise: - As of 2011, 645 people work in the Department of Banking Supervision (from 729 two years ago). - Given demands from the Basel process and movement to more continuous supervision for twelve of the largest banking companies, staffing should be reviewed to ensure appropriate quantity and quality of staff. - Reassess general practice of rotating people across RBI departments to develop specialized expertise; retain bulk of supervisory/regulatory staff to spend the vast majority of their career in bank supervision/regulation. - Consolidation and methodology: - Increase focus on consolidated risks of the banking group; consider methodology for rating banking companies to reflect systematically issues at nonbank subsidiaries. - Issue clearer guidance on need for banking groups to provide updates between annual financial inspections. - Ensure review and validation of models used for internal risk management, even if not yet used for regulatory capital purposes. ### Supervisory techniques (CP 20) - RBI utilizes onsite supervision and offsite monitoring; principal improvement needs include: 1. Provide a regular forum for regional office inspectors and central office to review findings, insights, and questions, especially when introducing new supervisory approaches. 2. More intensive reviewing of nonbank subsidiaries. 3. Improved monitoring of foreign operations through better information flow from overseas supervisors and/or more overseas inspections. 4. Ensure critical review and validation of risk management models not yet used for regulatory capital purposes. 5. Develop more structured interaction throughout the year with directors of private sector banking companies. 6. Initiative begun: a Steering Group, led by a deputy governor, began a year-long review process in April 2011 to consider changes; Department of Banking Supervision announced restructuring to move offsite monitoring closer to onsite inspections; a new supervisory regime for the largest (12) banking companies was planned, involving (i) moving supervisory responsibility from regional offices to central office, and (ii) shifting from once-a-year to a more continuous supervisory approach with targeted reviews. ### Supervisory reporting (CP 21) - RBI does not have the power to require information from affiliated but unregulated entities of a banking group; a legal amendment has been proposed to address this concern. ### Accounting and disclosure (CP 22) - RBI does not have direct authority to rescind appointment of a statutory auditor; historically it has withdrawn approval when serious deficiencies are identified. - Financial statements are based on accounting standards prescribed by ICAI, not internationally and widely accepted accounting standards. - Convergence with IFRS for banks is scheduled to commence from April 2013 onwards. - In India, standards on financial instruments (AS 30, 31, and 32) have not been notified and are therefore not binding. - RBI issues prudential guidelines on investment classification and valuation, income recognition, asset classification, and provisioning to fill gaps. - RBI does not have access to external auditors’ working papers; recommended to increase interaction with external auditors. ### Corrective and remedial powers of supervisors (CP 23) - RBI has broad discretion and a prompt corrective action regime, with tools for problem bank resolution. - Gaps related to public banks and capital definitions: 1. RBI cannot disempower a public bank to carry on banking activity. 2. Within Prompt Corrective Action, discretion may allow a bank to operate for potentially in excess of a year with extremely low capital; given that CRAR is a total capital concept, a 3 percent total capital level could involve very little (common) equity. 3. RBI can appoint the chief executive officer or additional directors for a problem bank, but these persons are not granted additional powers; RBI should provide greater clarity to these roles. ### Consolidated supervision (CP 24) - RBI has taken steps to broaden supervisory focus to include consolidated group oversight via FSDC, subcommittees, inter-agency meetings, implementation of consolidated norms, and supplemental consolidated returns. - Remaining gaps: 1. RBI cannot order inspections of, or require reports from, domestic nonbank subsidiaries it does not regulate; a proposed amendment (new Section 29 (A) of the Banking Regulation Act, Power in Respect of Associated Enterprises) would address this deficiency. 2. RBI does not receive inspection reports directly from nonbank supervisory agencies; timeliness and regularity should be improved compared to current practice of obtaining such reports from the parent bank at annual financial inspection. 3. Opportunities to improve inter-agency meetings: - Ensure they take place on a fully regular schedule (for designated conglomerates and other banking companies with substantial nonbanking operations). - Provide for regulators-only portions to allow candid conversation. 4. Consider methodology for rating banking companies to reflect issues at nonbank subsidiaries. 5. Major gaps in home/host information sharing arrangements as detailed in CP 25. - RBI has not used powers to conduct overseas inspections since 2008. ### Home-host relationships (CP 25) - Grading: Materially noncompliant (MNC). - Key findings and gaps: 1. Indian banks have overseas operations in more than 45 jurisdictions, but RBI has MOUs with only two, and informal information sharing arrangements to varying degrees with only a few others — material gaps in information flow. 2. RBI has not filled gaps through overseas inspections; it has not done any overseas inspections since one was done in May 2008. 3. RBI has not hosted any supervisory colleges to reach out to host jurisdictions. 4. Given operations in countries in unstable regions or with varying supervisory strength, increased supervisory dialogue with host supervisors is appropriate. 5. RBI does not clearly assess during licensing whether home countries of foreign banks seeking to open offices practice consolidated supervision; nor does it carry out consistent, rigorous analysis of the quality of host country supervision. ### Aggregate assessment - Aggregate: Compliant (C) – #, Largely compliant (LC) – #, Materially noncompliant (MNC) – #, Noncompliant (NC) – #, Not applicable (N/A) – # ### Selected recommendations from Table 2: India — Recommended Action Plan - CP 1 (Objectives, Independence, Powers, Transparency and Cooperation): - Remove impeding provisions from related acts; clarify role of nominee director in public banks; specify legal reasons for removal of head of supervisory agency; reconsider strict rotation policies; enshrine in law protection for costs of defending supervisors; address limited flow of regular information from domestic nonbank supervisors by developing mechanisms for written material sharing, broadening escalation protocols, and regularly holding semi-annual meetings with regulators-only option. - CP 3 (Licensing Criteria): - Put in place closer ex ante review of intended risk management and control systems for new banks; require foreign bank applicant subject to overall consolidated supervision in home country; consider ongoing information exchange with home country as licensing condition. - CP 4 (Transfer of Significant Ownership): - Incorporate a more judgmental test of “controlling interest.” - CP 5 (Major Acquisitions): - Enhance ability to monitor risks of nonbank subsidiaries and seek legal authority to request information for unregulated entities; implement systematic approach to critical review of host country supervisory arrangements. - CP 6 (Capital Adequacy): - Issue regulatory guidelines requiring adequate distribution of capital among different entities of the banking group; address challenges from Basel II advanced model implementation; enhance supervisory policies for banks using Basel II advanced models. - CP 7 (Risk Management Process): - Require periodic and rigorous model review and validation by banks; ensure risk guidance is applied to consolidated banking company. - CP 8 (Credit Risk): - Introduce requirement that major credit risk exposures exceeding a certain amount or percentage of capital, or unusually risky exposures, be decided by senior management; require potential future exposure be included in credit management strategies or policies. - CP 10 (Large Exposures): - Establish more detailed requirements and guidance on criteria for “connected exposures”; allocate more time/resources to assess definition of “connected exposures” during annual review; lower the 40 percent consolidated borrower large exposure limit (which can be raised to 50 percent in exceptional circumstances) to align with good practice. - CP 11 (Related Parties): - Include shareholders and promoters in definition of related parties; require by law that loans to subsidiaries and joint ventures be on an arm’s length basis. - CP 15 (Operational Risk): - Introduce requirement for banks to inform RBI of any adverse developments in operational risk. - CP 17 (Internal Control/Audit): - Ensure updates on developments affecting fit and proper test for existing directors are received; ensure annual financial inspection assesses quantity and skill level in risk management and control functions. - CP 19 (Supervisory Approach): - Review staffing for Basel process and continuous supervision demands; reassess rotation policy to develop specialized expertise; increase focus on consolidated risks; issue clearer guidance on updates between annual inspections. - CP 20 (Supervisory Techniques): - Introduce specific forum for regional inspectors and central office interactions; perform more intensive reviews of nonbank subsidiaries; improve monitoring of foreign operations via better information flow and overseas inspections; ensure model validation; develop structured interaction with directors. - CP 21 (Supervisory Reporting): - Introduce power to require information from affiliated but unregulated entities. - CP 22 (Accounting/Disclosure): - Obtain access to external auditors’ working papers; increase interaction with external auditors. - CP 23 (Supervisors’ Corrective and Remedial Powers): - Consider applicability of remedial powers to public banks. - CP 24 (Consolidated Supervision): - Empower RBI to require inspections of, or reports from, domestic subsidiaries it does not regulate and to receive inspection reports directly from nonbank supervisory agencies; improve inter-agency meeting schedules and regulators-only portions; conduct overseas inspections more regularly. - CP 25 (Home-Host relationships): - Promptly address gaps in information flow through MOUs or other means; consider hosting supervisory colleges; assess during licensing whether home countries of foreign banks practice consolidated supervision through rigorous and consistent analysis. - Prepare representatives for international forums by better coordination and focus among RBI departments. *Source: _cr13267 - 16. Interest rate (IMF PDF chapter content provided).* ### 48. RBI welcomes the comprehensive review of banking regulation and supervision ### RBI welcomes the comprehensive review of banking regulation and supervision ### Summary of RBI's response and overarching positions - RBI welcomes the comprehensive review by the joint IMF-World Bank team and notes the assessment was “extensive, comprehensive and productive.” - The assessment was conducted “with respect to the highest international standards” and RBI welcomes the opportunity to comment. - RBI recognizes “no room for complacency” despite India emerging “relatively unscathed from the crisis.” - India, as a member of the Financial Stability Board, Basel Committee on Banking Supervision, and IMF, is “actively participating in post crisis reforms” and is “committed to adoption of international standards and best practices, wherever necessary, and in a phased manner and calibrated to local conditions.” - RBI’s stated intention: not only to implement international standards and best practices, but “also be ahead of the minimum requirements.” ### Key gaps and constraints identified by the assessment (as acknowledged by RBI) - Most significant gaps: - International supervisory information sharing and cooperation. - To a lesser extent, domestic supervisory information sharing and cooperation. - Other major gaps: - Consolidated supervision of financial conglomerates. - Some limits on the de jure independence of RBI. - RBI notes: “while RBI lacks de jure independence, there has been no de facto interference from the government.” ### Actions and commitments on supervisory information sharing and cooperation - Ongoing efforts to establish information sharing mechanisms where Indian banks operate. - Current and planned arrangements: - “Information sharing arrangements with four jurisdictions.” - “MOUs with another 12 jurisdictions are expected to be reached shortly.” - RBI also maintains “informal arrangements with major jurisdictions for information sharing.” - RBI acknowledges this is “a time consuming process” and aims to “establish appropriate information sharing networks as quickly as possible.” - Efforts are on to establish supervisory colleges to “increase the efficacy of supervision.” ### Measures addressing financial conglomerates and interconnectedness - RBI has taken several steps toward effective supervision of financial conglomerates; key steps include: - Prudential limits on aggregate interbank liabilities as a proportion of their net worth. - Restricting access to uncollateralized funding market to banks and primary dealers, and caps on both lending and borrowing by these entities. - Restricting investment in the capital instruments of other banks and financial institutions to “10 percent of investing banks’ capital funds,” plus the stipulation that a bank cannot hold more than “5 percent of other bank’s equity.” - Tight limits on banks’ exposure to NBFCs and progressively more stringent prudential regulation of NBFCs. - Restrictions on exposures to complex activities and products and a system for intensive monitoring of financial conglomerates and for common exposures in sensitive sectors. ### Position on RBI nominee directors on bank boards - RBI recognizes the “moral hazard issues” posed by appointing an RBI officer as a nominee director. - Historical and legislative adjustments: - Acts were amended to provide for appointment of “one director possessing necessary expertise and experience in matters relating to regulation and supervision and regulation of commercial banks, by the central government on recommendation of RBI,” which allowed RBI latitude to avoid placing serving officers on bank boards. - Serving officers were replaced by retired RBI officers; the transition “was not particularly satisfactory,” and “currently serving officers are being nominated.” - RBI has taken up with Government of India “for amendment of the enabling provisions of the Act under which RBI nominee directors are appointed.” ### Ownership neutrality, penalties, and treatment of foreign banks - RBI reiterates regulations are “completely ownership neutral” with the same level of scrutiny applied to public and private sector banks. - Foreign banks “have the same amount of freedom as the domestic banks have (except regarding expansion)” and are “treated exactly on par with the domestic banks for prudential purposes.” - When penalties are imposed on a public sector bank, RBI states it does not consult the government and “we place penalty imposed in public domain just as we do for the private sector banks.” ### Rationale on large exposure/group borrower limits - RBI recognizes the group borrower limit is different from the single borrower limit and is “significantly larger than the international norms.” - RBI’s justification: - Deviation is driven by development needs: “Some of the major corporate groups, which are also the drivers of growth in Indian economy, have grown very rapidly compared to banks.” - Keeping the group borrower limit at the level of single borrower limit “would severely constrain the availability of bank finance” to these corporate groups and “would hamper the growth of the economy.” - Reduction in lending could leave banks “with surplus lendable resources which may result in adverse selection.” - The deviation is attributed to “compulsions of robust growth, investment needs of infrastructure and the demand ushered in by increasing financial inclusion.” ### RBI’s stance on FSAP and international dialogue - RBI recognizes the importance of the FSAP in promoting financial stability and serving Indian interests. - RBI is “committed to meet the best international practices that are appropriate for us.” - RBI “expresses its strong support for the role FSAP plays in promoting the soundness of global financial system and looks forward to a continuing dialogue with the IMF/World Bank and other global counter parts.” ### Detailed assessment — Principle 1 (Objectives, autonomy, powers, and resources): key descriptions and findings - Principle summary: Effective supervision requires clear responsibilities and objectives, operational independence, transparent processes, sound governance, adequate resources, accountability, and legal frameworks including information sharing and confidentiality protections. - Principle 1(1) Responsibilities and objectives — Description highlights: - RBI: autonomous body created under the Reserve Bank of India Act 1934; sole responsibility for regulation and supervision of banks under the Banking Regulation Act 1949. - Objectives of supervision defined in various articles of the Banking Regulation Act, particularly “Section 22 and Section 35A,” focusing on safety and soundness of the banking system. - Laws and regulations provide framework of minimum prudential standards. - SEBI, IRDA, FIU-IND, and PFRDA roles are described for securities, insurance, financial intelligence, and pensions respectively. - Principle 1(1) — EC2 and EC3 highlights: - Section 17 of the RBI Act lists business RBI can transact; Article 15A and Section 17 grant RBI authority to exercise powers and functions. - Banking Regulation Act (BR Act) provides licensing, business activity, capital, liquidity, governance, penal provisions, winding up and liquidation frameworks. - Foreign Exchange Management Act 1999 empowers RBI to regulate foreign exchange market. - Payment and Settlement Systems Act mandates RBI to regulate and supervise payment and settlement systems. - RBI vested with broad powers in “Section 35A and Section 36 of the BR Act” to issue guidelines to banking companies. - RBI has mandatory prudential guidelines on liquidity management, capital adequacy, income recognition, asset classification and provisioning, connected lending, large exposures, securitization, derivatives and risk management. - BR Act was last amended in “2007.” The Banking Laws (Amendment) Bill, 2011 was introduced in parliament on “March 22, 2011.” Financial Sector Legislative Reforms Commission (FSLRC) was constituted on “March 24, 2011.” - Principle 1(1) — EC4 disclosures and publications: - RBI publishes fortnightly consolidated statements under “Section 43 of the RBI Act” containing aggregate liabilities and assets of scheduled commercial banks. - Regular publications include Banking Statistics, Report on Currency and Finance, Report on Trends and Progress of Banking in India (Section 36(2) of the BR Act), Credit Information Review, monthly RBI bulletin, and weekly statistical supplements. - Listed banks required to publish quarterly unaudited financial statements per SEBI; all banks must publish limited financial data at half yearly intervals and annual audited financial statements. - Disclosures under Pillar III of Basel II required to be published with annual financial statements by all banks. - Principle 1(1) — Supervisory program and resource allocation: - AC1: “As outlined in CP 20, the RBI takes into account the risks posed and the different approaches to mitigate those risks by individual banks and banking groups in setting its supervisory program and allocating resources.” - Assessment: “Compliant.” ### Principle 1(2) Independence, accountability, and transparency — legal and institutional observations - RBI is “solely responsible for the regulation and supervision of all commercial banks” and primary objective is consolidated supervision of commercial banks, financial institutions and NBFCs. - Governance structure: - Management rests with the Central Board of Directors (Section 8 of the RBI Act). - Governor and a deputy governor appointed by the central government for a term “not exceeding five years and are eligible for reappointment” (Section 8 (4) of the RBI Act). - Central Board of 20 members: governor, four deputy governors, 14 directors and one government official nominated by the central government. - No history of central government making frequent changes to Central Board composition. - Board practices require a director to raise conflict of interest before discussion and abstain from participation. - Legal provisions that “appear to undermine” RBI independence: - Section 7 of the RBI Act allows the central government to give directions to the Bank “as it may, after consultation with the governor, consider necessary in the public interest.” - Section 35 (1) and (4) grant the central government power to direct the RBI to cause an inspection to be made; Section 35 (4) allows government to defer, pass, cancel or modify specific orders of RBI under terms it may think fit to impose. - Section 22 (5) allows a banking company aggrieved by RBI’s decision to cancel a license to appeal with the central government within “30 days”; the decision of the central government “shall be final (Section 22 (6)).” - The BR Act does not empower the RBI to enter into Memoranda of Understanding (MOU) with other jurisdictions without the approval of the central government. - Section 11 of the RBI Act allows the central government to remove the governor or the deputy governor from office during their term; the law “does not place any obligation on the government to publicly disclose the reasons for the removal.” *Italic source: _cr13267 - 48. RBI welcomes the comprehensive review of banking regulation and supervision* ### Section 30 of the RBI Act allows the central government to supersede the Central Board if ### _cr13267 - Section 30 of the RBI Act allows the central government to supersede the Central Board if ### Legal provisions for supersession and government powers - Section 30 of the RBI Act allows the central government to supersede the Central Board if the RBI fails to carry out any of the obligations imposed on it under the RBI Act. - When supersession is exercised, the central government may entrust the general superintendence and direction of the affairs of the RBI to the agency as the central government determines. - The central government must outline the circumstances leading to such action in a full report to parliament at its earliest opportunity and in any case within three months. - In practice: - Provisions under (a), (b), (e) and (f) have never been used. - Provision (c) has been used only once for a NBFI but the RBI had it successfully overturned in Court. - With regard to (d), with the approval of the central government, the RBI has concluded MOUs with two jurisdictions and has a significant number of MOUs in the pipeline. ### Independence and conflicts - Legal and regulatory features that may compromise RBI independence: - A representative of the RBI acts as a nominee director on the Board of public sector banks; this is generally a current RBI employee from a department other than bank supervision. - Assessors received evidence that this director takes an active role in Board discussions and is sometimes implicitly relied upon to ensure regulatory compliance, blurring the distinction between supervision and active management. - Public sector banks represent more than 70 percent of the Indian banking market. - Assessors’ view and recommendations: - The authorities should abolish the role of the nominee director. - As a second best or intermediary solution, provide greater clarity to the limitations of the role to avoid the appearance of the RBI becoming involved in a bank’s management. - The BR Act should allow the RBI to enter into MOUs without the agreement of the central government. ### Governance and supervisory structure - Board for Financial Supervision (BFS): - BFS is a committee of the Bank’s Central Board of Directors, constituted by the Bank’s Central Board’s Regulation 1994 under subsection (i) of Section 58 of the RBI Act 1934. - The governor is the Chairman of BFS. - Membership: governor (Chairman), four co-opted directors from the Central Board as members for a term of two years, deputy governors of the Reserve Bank as ex-officio members. - One deputy governor, usually the deputy governor in charge of banking regulation and supervision, is nominated as the Vice-Chairman. - BFS meets generally once a month and provides continuous direction on regulatory policies including governance issues and regulatory practices; it considers inspection reports and other supervisory issues placed before it. - Audit Sub-Committee within BFS: - Aims to upgrade the quality of statutory audit and internal audit functions in banks and financial institutions. - Includes a deputy governor as chairman and two directors of the Central Board as members. - Supervisory departments overseen by BFS: - Department of Banking Supervision (DBS), Department of Nonbanking Supervision (DNBS), and Financial Institutions Division (FID). ### Information exchange, MOUs, and international coordination - Domestic exchange: - No formal arrangement exists for exchanging written information between domestic regulators; no MOUs or comparable formal mechanisms are in place. - RBI can obtain copies of other domestic regulators’ inspection reports from banks, often with a time lag. - Semi-annual and quarterly meetings between RBI, SEBI, and IRDA provide for some information exchange. - Financial Stability and Development Council (FSDC) set up in December 2010 under the Chairmanship of the Union Finance Minister, with members from the RBI, SEBI, IRDA, PFRDA, and the government; a Sub-Committee under the FSDC was set up with the governor of the RBI as Chairman. - International exchange: - RBI has a significant gap in information-exchange arrangements with foreign authorities. - RBI has entered into MOUs with two foreign supervisory authorities. - Indian banks operate in over forty-five jurisdictions through branches, subsidiaries, and joint ventures, and informal arrangements are limited. - Legal confidentiality provisions: - Section 45E of the RBI Act: no court can require or any other authority can compel the RBI to disclose information obtained by it under Section 45C or furnished under Section 45D. - Section 28 of the BR Act: RBI is only allowed to disclose information obtained under the BR Act in aggregated form. - Assessment of cooperation: Materially non-compliant. - Assessors’ recommendations for information exchange: 1. Mechanisms should be found for written material (including inspection reports) to be regularly shared on a timely basis. 2. Escalation protocols should be appropriately broad (covering IRDA as well as SEBI directly) and fully operational to promptly alert other relevant supervisors about concerns. ### Human resources, staffing, and protection - Staff numbers and rotation: - As of 2011, 645 people work in the Department of Banking Supervision including the regional offices; the number declined from 729 two years ago. - RBI applies a strict rotation policy among its staff, ensuring staff rotate to other positions after three to four years. - Assessors suggest reconsidering strict rotation policies so staff can build up expertise in banking supervision and regulation; rotation areas could be narrowed to similar areas of expertise (e.g., DBS, DBOD and other departments involved in supervision of NBFIs). - To address regulatory capture, rotations of supervisors assigned to specific supervised entities should be implemented. - Given future demands from Basel II and Basel III and movement to more continuous supervision, staffing levels should be reviewed to ensure appropriate quantity and quality of staff. - Financing and training: - RBI is financed through its resources and does not receive financial support from the central government nor from the industry. - Major sources of income: (i) the deployment of foreign currency assets and gold and (ii) interest on domestic securities and market operations. - The budget for banking supervision is sufficient to hire outside experts, travel to onsite inspections and invest in information technology. - Training resources: Reserve Bank Staff College, Chennai; College of Agricultural Banking, Pune; Institute for Development and Research of Banking Technology, Hyderabad; and international training programs and secondments to commercial banks. - Legal protection for supervisors: - BR Act Section 54: No suit or other legal proceeding shall lie against RBI or any of its officers for anything or any damage caused or likely to be caused by anything done in good faith or intended to be done in pursuance of the BR Act. - Legal Department confirmed protection extends to the Board of the RBI and employees beyond their termination of employment or appointment. - As a matter of practice, employees’ costs of defending actions made while discharging duties in good faith are borne by the RBI; assessors recommend this protection for defense costs be stated more clearly, preferably in law or at least at the level of internal procedures, including financing of expenses from the start of legal proceedings. - Assessment: AC 1 The governor appointment framework — Assessment Materially noncompliant. - The governor is appointed for a maximum term not exceeding five years and is eligible for reappointment; there is no specified minimum term in law. - The reasons for removal of the head of the supervisory agency during his term are not specified in law; assessors note the Law should specify removal reasons and the requirement to disclose them. ### Legal powers, access, and enforcement - Licensing and revocation: - Section 22(1) of the BR Act: RBI powers to issue a license to commence and carry on the business of banking. - Section 22(4) of the BR Act: RBI powers to revoke license. - RBI does not license state owned banks (these are set up by separate Acts) and cannot disempower a state owned bank to carry on banking activity. - Rulemaking and guidance: - Sections 35A and 36 of the BR Act: RBI has the power to set mandatory prudential rules by issuing directions or guidelines. - Guidance notes reflect supervisory expectations and are issued in the form of Circulars; at the end of June every year circulars are bundled into Master Circulars and published on the RBI’s website. - RBI consults with industry by placing proposals on its website before issuing guidelines; industry participants confirmed suitable time is given for comments. - Access to information: - Section 27(1) BR Act: every banking company shall submit to the RBI a monthly prudential return. - Section 27(2) BR Act: RBI may request any information from banking companies in the form and frequency it deems necessary. - Section 35(2) BR Act: duty of every director or officer of a banking company to produce to any RBI officer making an inspection all books, accounts, and other documents in his custody and to furnish statements and information as required. - Assessment: Compliant. - Enforcement powers: - Section 35A BR Act: RBI can issue directives to banking companies for public interest, banking policy, depositor protection, and securing proper management. - Sections 46 and 47 BR Act: authorize RBI to take action against banking companies that fail to comply with the BR Act, including imposition of monetary penalties and potential criminal liability. - Section 22(4): authorizes RBI to cancel the license of a banking company; does not have similar authority for public banks (which account for more than 70 percent of the market). - Assessment: Largely Compliant. Comment: RBI lacks authority to cancel the licenses of a public bank. ### Assessments and key recommendations (summary) - Governance and independence: - Remove legal provisions that allow the central government to give directions to the RBI, require inspections, overrule decisions, or supersede the Central Board; alternatively, formally ground RBI independence in the RBI Act. - Nominee director on public sector banks: - Abolish the role of the nominee director on public sector bank boards, or at minimum clarify legal limitations on the role. - MOUs and international cooperation: - Allow RBI to enter into MOUs without central government agreement. - Accelerate the process of entering into formal MOUs with foreign supervisors given Indian banks operate in over forty-five jurisdictions. - Staffing and rotation: - Reconsider strict rotation policies to enable staff to build expertise in banking supervision and regulation, narrow rotation areas to similar specialties, implement rotations for supervisors assigned to specific supervised entities, and review staffing levels for Basel II/Basel III and continuous supervision. - Legal clarity: - Specify in law the reasons for removal of the head of the supervisory agency and require disclosure. - Clarify protection for costs of defending supervisors' actions, preferably by law or internal procedure, including financing from the start of proceedings. - Information exchange and domestic coordination: - Establish formal mechanisms for timely written exchange of supervisory material (including inspection reports) among domestic regulators. - Ensure escalation protocols are operational and appropriately broad to promptly alert relevant supervisors. *Source: _cr13267 - Section 30 of the RBI Act allows the central government to supersede the Central Board if* ### 3. the semi-annual meetings on major banking companies (i.e., the designated bank-led ### 3. the semi-annual meetings on major banking companies (i.e., the designated bank-led ### Semi-annual meetings and proposed BR Act amendment - Semi-annual meetings on major banking companies (designated bank-led financial conglomerates, and other SIFIs that engage in appreciable insurance or securities activities) are held on a fully regular basis, involving representatives of the supervised firm and allowing an opportunity for regulators-only discussion of issues regarding that banking company. - Proposal to insert a new Section 29 (A) in the BR Act that would allow the RBI to call for information from any entity in the banking group. - Expected effect: Direct access by the RBI to information on subsidiaries and associated companies would be improved with the passage of this proposed amendment. ### Principle 2 — Permissible activities - Principle summary: The permissible activities of institutions licensed and supervised as banks must be clearly defined, and the use of the word “bank” in names should be controlled as far as possible. - EC1: The term “bank” is clearly defined in Section 5 of the BR Act. - EC2: The permissible activities of banking companies are enumerated in Section 6.1 of the BR Act, with Section 6.2 explicitly prohibiting a banking company from engaging in any other activities. - Activities of subsidiaries of banking companies are limited to those permissible to the bank directly. - Mutual fund and insurance activities are permissible under the law for banking companies, but the RBI has limited engagement in them; they cannot be engaged in through a department of the banking company. - Banks can set up subsidiaries engaged in some data processing and IT activities. - EC3: Section 7 of the BR Act limits the use of terms such as “bank,” “banker,” and “banking” to licensed banking companies, and requires that such licensed banking companies incorporate “bank” in their names. - EC4: Several classes of nonbanking companies can take deposits other than demand deposits: Development Financial Institutions and Nonbanking Financial Companies (both subject to RBI supervision), and Corporations. The deposits are not covered by deposit insurance. - EC5: The RBI maintains a current list of all authorized banking companies on its web-site; updates are specifically made public through issuance of a circular. - Assessment: Compliant - Comments: Banking is well defined in Indian Banking Law, with a clear line of demarcation from nonbanking companies. Activities that a banking company can engage in are clearly specified. ### Principle 3 — Licensing criteria - Principle summary: The licensing authority must have power to set criteria and reject applications that do not meet standards; licensing must assess ownership, governance, fitness and propriety, strategic and operating plans, internal controls and risk management, and projected financial condition. For foreign owners, prior consent of home-country supervisor should be obtained. - EC1: The RBI is both the supervisory authority and the licensing authority. Licensing decisions can be appealed to the central government; if over-ruled by the central government, the RBI could petition the courts for review. The RBI provided documentation of successful court review of a central government decision that had over-ruled an RBI decision. - EC2: No approvals of domestic bank licenses for a number of years following problems at some recently established private banks. Legal authorities: RBI issues licenses only after tests of entry specified in Section 22 (3) of the BR Act have been fulfilled. RBI reviews capital to ensure it meets the minimum requirement and assesses ownership structure, operating plans and controls, ability to pay present and future depositors in full, quality of management, and whether licensing would be in the public interest. - EC3: Criteria for issuing licenses are generally consistent with ongoing supervision, although governance and risk management expectations are not explicitly built into licensing provisions. - EC4: RBI has implicit authority to deny applications if criteria are not met; practical failure to approve constitutes effective denial. - EC5: Under Section 22(3) (c) of the BR Act, proposed management is evaluated to ensure it will not be prejudicial to the public interest or the interests of present or future depositors. Licenses could be denied if group is not widely held, not regulated, not publicly listed, or lacks transparency. - EC6: RBI reviews ownership structure of proposed banks with a test of 5 percent ownership of shares as threshold for review and acknowledgement established by regulation. - EC7: Section 22(d) requires RBI to ensure adequacy of capital before granting a license. RBI Guidelines issued on January 3, 2001: initial minimum capital of a new bank as Rs. 200 crore, which would be raised to Rs. 300 crore within three years of commencement of business. - EC8: Fit-and-proper elements applied to directors. Under the Companies Act, people with criminal convictions are ruled out as directors. Section 10-B (4) of the BR Act: chairman/managing director must have specified banking or financial qualifications. Qualifications of other directors are reviewed to satisfy preferred areas of expertise in Section 10A. Subsequent Board changes not approved ex ante, except full-time directors of private banks are reviewed before the fact by RBI; for public banks an Appointments Board chaired by the governor of the RBI develops nominees confirmed by the Ministry of Finance and central government. Other director changes must be reported under an Operating Circular. Annual Financial Inspections (AFI) review nominating committee exercise in selecting new directors. - EC9: RBI reviews proposed strategic and operating plans to determine whether appropriate corporate governance, risk management, and internal controls will be in place, but does not determine prior to authorization the proposed systems that will be used in practice; these are covered in the annual inspection of the new bank, typically within 18-24 months of establishment rather than within 6-12 months. - EC10: Rule 11 of the Banking Regulation (Companies) rules, 1949: applications filed in prescribed form (Form III) require submission of a project report covering business potential and viability; pro forma financial statements and projections included; financial information on promoters, including financial worth and business interests (including details on credit outstanding), is reviewed. - EC11: RBI obtains a non-objection letter from the home country supervisor before granting a license to a foreign bank; it reviews quality of supervision exercised by home supervisor, but does not explicitly consider whether it practices consolidated supervision overall, nor have a clear template for analysis of overall quality of supervision. Consolidated supervision is reviewed only in the context of the proposed office falling within the supervisor’s responsibility, and qualitative assessment appears to have little analytical structure. - EC12: RBI has power under Section 22 (4) to cancel a license if conditions are not complied with. Strong penalties under Section 46 can be imposed for false statements generally. - Note: RBI does not have authority to disempower a state bank to carry on banking activity, as state banks are not subject to Section 22 of the BR Act. - EC13: Section 10A(2) mandates not less than 51 percent of the directors have special knowledge or practical experience in accountancy, agriculture, banking, co-operation, economics, finance, law, small scale industry etc. Fit and proper criteria established by RBI to ensure directors understand the risk profile of a bank. - AC1: Assessment includes evaluation of ability of shareholders to supply additional capital support if needed. - AC2: New banks and established banks subject to off-site supervision through mandated prudential returns (See CP 21.) and AFI process; AFI for new banks focuses on compliance with licensing conditions. - Assessment: Largely Compliant - Comments: RBI has a clear licensing process and discretionary judgment, although no domestic licenses granted for a number of years. Areas to strengthen: - Putting in place a closer ex-ante review of intended risk management and control systems of a proposed new bank and/or ensuring examination at a very early stage of operations (within the first six to twelve months); - Requiring more clearly that a foreign bank applicant is subject to overall consolidated supervision in its home country; - Considering inclusion of a requirement for on-going information exchange with the home country supervisor as a condition for licensing an office of a foreign bank. ### Principle 4 — Transfer of significant ownership - Principle summary: The supervisor has the power to review and reject proposals to transfer significant ownership or controlling interests in existing banks. - EC1: Neither banking law nor regulations specifically define significant ownership and controlling interest, but BR Act Section 5(ne) defines “substantial interest” as beneficial ownership of the lesser of Rs 5 lakhs or 10 percent of the paid-up capital of the company. Section 12 (2) restricts specific shareholders from voting more than 10 percent of the shares, and regulations under Section 35A require RBI acknowledgement for 5 percent shareholding. - EC2: Pursuant to Section 35A, any transfer of shares exceeding 5 percent of paid-in capital requires acknowledgement by the RBI. - EC3: Under Section 35A, RBI has power to reject any proposal for significant change in ownership or controlling interest in a bank. - EC4: RBI can monitor shareholdings even below the 5 percent level through reports requested beginning in August, 2005, from private sector banks on details of share transfers that resulted in changes in shareholdings of any individual entity of 0.5 percent. - EC5: RBI has a prior approval process at the 5 percent level. If transfers occur without approval, RBI can direct the bank to reverse the transfer. - AC1: Neither law nor regulations require banks to notify RBI if they become aware of material information that could negatively affect suitability of a major shareholder. - Assessment: Compliant - Comments: RBI has legal authority and procedures to review ownership changes. Definition of substantial interest focuses on beneficial ownership. Prospect exists for control exercised by means other than shareholdings; appropriate to incorporate a more judgmental test of controlling interest. Possibility of change in ownership of an existing shareholder not subject to review. ### Principle 5 — Major acquisitions - Principle summary: Supervisor has power to review major acquisitions or investments by a bank, including establishment of cross-border operations and confirmation that corporate affiliations/structures do not expose bank to undue risks or hinder supervision. - EC1: Under Section 35A, banking companies can, with prior RBI approval, acquire more than 50 percent of shares of a company engaged in activities permissible under Section 6 of the BR Act; insurance and mutual funds cannot be engaged in through a department of the bank itself. Banking companies cannot acquire between 30 percent and 50 percent of shares except with concurrence of the central government in addition to RBI approval. - Banking companies can acquire less than 30 percent of shares of any company regardless of activities. - Section 19 (2): aggregate equity investments by a banking company in shares of other companies must be less than 30 percent of the bank’s equity. - By RBI regulation, amount of such investments is further limited to 10 percent of the banking company’s own equity by individual investment and 20 percent in the aggregate. - EC2: Criteria for proposals include activity and investment limits specified under EC1. Other aspects spelled out in Master Circular, “Para banking activities” issued on July 1, 2010. Acquisition proposals evaluated in terms of prospective effects on financial condition and desirability. - EC3: Potential for acquisitions to expose investing bank to undue risk is limited because most investable companies are subject to supervision by another Agency (e.g., SEBI, IRDA, National Housing Bank), although some nonregulated companies can be acquired. Unregulated subsidiaries can be established principally in information technology/data processing. - Under Section 19, RBI reviews prospective establishment of foreign branches or subsidiaries and has discretion to deny applications if concerns (such as secrecy laws prohibiting free flow of information) exist. - EC4: All proposals for major acquisitions are evaluated for impact on the bank and ability of acquirer to manage the investment/acquisition. - EC5: Some acquisitions can be made without RBI approval: shares held in the trading book and shares amounting to less than 30 percent of the shares of an investee (non-financial) company subject to the limits described above; no requirement that companies invested in engage only in activities closely related to banking. - EC6: Except for investments under the 30 percent threshold, RBI is made aware of intended investments before they occur. However, capacity of RBI to monitor activities of subsidiaries to ensure they are not posing risks to a banking group is constrained. - AC1: Under Section 19 (1), any prospective foreign operation of an Indian bank requires prior approval of the RBI. In reviewing such filings, RBI determines broadly that appropriate supervisory arrangements in host country are in place, although extent of review appears limited. If requested, RBI advises the host country that it is the supervisor and regulator of the banking company. - Assessment: Largely Compliant - Comments: Structured approach has key elements to ensure banking company focuses on banking activities and provide RBI oversight on expansion. Areas to address include: 1. The capacity of the RBI to monitor the risks of a nonbank subsidiary, and to take action to address on a very timely basis circumstances where problems surface, is limited, such as by: - potential time-lags in getting information concerning entities regulated by other Agencies; and - lack of legal authority to request information for unregulated entities. *IMF staff report excerpt* ### 2. A more systematic approach to critical review of host country supervisory ### 2. A more systematic approach to critical review of host country supervisory arrangements should be developed and implemented. ### Principle 6 — Capital adequacy - Key regulatory requirements and implementation - Capital adequacy requirements implemented through the Master circular “Prudential guidelines on Capital Adequacy and Market Discipline” (the MC) last updated on 1 July 2010. - Banks on a solo and a consolidated basis are required to maintain a Capital Adequacy Ratio of at least 9 percent of their risk-weighted assets as per the Basel II methodology (standardized approach for credit as well as market risk and basic indicator approach for operational risk) covering both on and off-balance sheet items (paragraph 4.1 of the MC). - Minimum Tier 1 capital ratio is prescribed at 6 percent (paragraph 4.1.3 of the MC). - System level capital ratio stood at 14.5 percent per cent at the end of March 2011. - Around 85 percent of Tier 1 consisted of common equity at the time of the assessment. - At present all banks in India are on the standardized approach for credit risk, the basic indicator approach for operational risk and the standardized approach for market risk. The RBI has published its timetable for adoption of the advanced approaches. - Components, limits, and conservatism - Paragraph 4.2. of the MC defines the components of Tier 1 and Tier 2. - Eligible instruments, prudential limits and their loss absorbing capacity are in accordance with the limits prescribed under the Basel I Accord (1988) as well as the Sydney Press release from 1998. - Deductions from capital are generally considered conservative. - Capital requirements apply equally to all commercial banks. - Supervisory powers and forward actions - Section 35A of the BR Act: RBI has legal power to impose a specific capital charge and/ or limit on all material risk exposures. - RBI will introduce a systematic assessment of relevant risk factors and the internal capital adequacy assessments of each bank and set individual capital ratios. - RBI will consider prescribing a higher level of minimum capital ratio for each bank under the Pillar 2 framework on the basis of its respective risk profile and risk management system. - RBI stated in paragraph 4.1 of the MC that banks are expected to operate at a level well above the minimum level. - In accordance with Section 35A of the BR Act, the RBI may issue a direction to a bank in the interest of the concerned bank, in the interest of the banking system or in the interest of its depositors. In practice the RBI is guided by its Prompt Corrective Action (PCA) framework. Under the PCA, supervisory responses are linked to three parameters i.e., net NPA ratio, capital adequacy ratio and return on assets. - Assessment and recommendations - Assessment: Compliant - Comments: RBI has set prudent and appropriate minimum capital adequacy requirements that reflect bank risks, defined components of capital in accordance with internationally agreed guidelines, and has the legal power to require higher capital ratios for individual banks. RBI’s requirements are stricter than applicable Basel requirements. RBI will move to Basel III on the internationally agreed timeline. - Recommendation: RBI should issue guidelines requiring adequate distribution of capital among different entities of the banking group. - Implementation challenges for Basel II advanced approaches: constraints on data, tools and methodologies, required skills for quantification and modeling of risks and validation of models; RBI to consider practical implementation issues and potential enhancements to supervisory policies and practices for effective supervision of banks applying advanced models. ### Principle 7 — Risk management process - Regulatory expectations and guidance - October 27, 1999 Circular (“Risk Management Systems in Banks”) articulated expectations for risk management structures. - 1999 Circular: primary responsibility for risk parameters and establishing risk management and control system rests with the Board of Directors; extended more explicitly to senior management in 2010. - Implementation may be assigned to a Risk Management Committee or to a Committee of top executives reporting to the Board. - AFI process: RBI reviews corporate governance issues including how risk management approaches are updated and communicated across the bank; limits and their exceptions are reviewed. - RBI has issued guidance in asset/liability management, liquidity risk, market risk, credit risk, and operational risk. - Governance, reporting, and internal processes - Efforts made to ensure Board has mix of skills needed to understand nature and level of risk and that Board and senior management receive necessary management information. - Banks have internal capital adequacy assessment processes evaluated by RBI under SREP. - Banks are required to appoint a senior officer as Compliance Officer; new product approval process typically involves the risk department; no legal/regulatory requirement for Board involvement (some banks’ policies require Board approval). - RBI advised banks to put in place robust risk management architecture, segregation of duties between front and back office functions, and recognition of need for independence in the middle office function of risk management. - Model validation and consolidation gaps - No current rigorous validation and independent testing of models and systems in the banks consistently required by, or conducted by, the RBI; these models are not currently used for regulatory capital purposes. Banks apply some independent testing from Internal Audit or External Audit. - Guidance has been issued only to the bank and not to the overall banking group; extent of focus on consolidated (vs. bank only) risk management in the RFI process appears limited. - Stress testing and other risk management tools - Detailed guidance on stress testing was issued on June 26, 2007. Banks were required to put in place appropriate stress test policies, and to ensure that they were operational as March 31, 2008. Compliance assessed through AFIs. - Through ICAAP and SREP processes there is some review of reputational and strategic risk. - Assessment and areas for improvement - Assessment: Largely Compliant - Comments: RBI has issued guidance on most key elements of risk management structure and operations; AFI process used to assess compliance. - Areas for improvement: - Establish a requirement for periodic and rigorous model review and validation by banks, even of internal risk models not currently used for regulatory capital purposes. - Ensure risk guidance is issued to, and applied strongly in practice to, the consolidated banking company rather than just the bank. ### Principle 8 — Credit risk - Governance and policy framework - RBI guidelines: Risk Management Systems in Banks (October 1999) and detailed Guidance Note on credit risk (October 2002). - Board of Directors responsible for credit risk management framework; credit risk management process must be articulated in bank’s Loan policy and approved by the Board (paragraph 3.1.5 of the Risk Management guidelines). - Boards should set limits by assessing bank’s risk and risk bearing capacity (paragraph 2.1 of the 1999 circular). RBI examiners confirm implementation during AFI. - Banks required to constitute a high-level Credit Policy Committee (CPC) and an independent Credit Risk Management Department. - 2002 Guidance note includes requirements on credit grading framework, portfolio surveillance and reporting, limit systems, portfolio review mechanisms and internal reporting; compliance assessed during AFI. - Directed lending and priority sector requirements - Commercial banks required to direct 40 percent of their Adjusted Net Bank Credit (ANBC) or credit equivalent amount of Off-Balance Sheet Exposure, whichever is higher toward priority sectors per MC “Lending to Priority Sectors.” For foreign banks, the required amount is 32 percent. - Priority sectors for domestic banks: agriculture, micro and small enterprise advances, and advances to weaker sections. For foreign banks: micro small enterprise advances and export credit. - Authorities state banks are not allowed to differentiate prudential norms between priority sector and other lending; usual due diligence procedures expected. - June 2011 Financial Stability Report indicates asset quality under priority sector lending, especially agriculture, deteriorated at a faster rate compared to overall asset quality. - Shortfalls in meeting the target: - For Indian banks: mandatory deposit of the shortfall for 7 years in the Rural Infrastructure Development Fund (on-lends to NABARD); deposit remunerated at a rate inversely proportional to the shortfall, and may be just 2-3 percent. - For foreign banks: deposit for 3 years with the Small Industry Development Bank, which refinances other banks lending to the priority sectors. - Related parties, access to information, and counterparty risk - Section 20 of the BR Act prohibits lending to connected parties (board members, entities in which they are interested, relatives); requires disclosure and non-participation in credit decisions. - Transactions with related parties such as subsidiaries, associates, joint ventures required to be at arms’ length and are a licensing condition. Adherence reviewed during Annual Financial Inspections. - Section 27(2) and Section 35(2) of the BR Act provide RBI powers to require statements, information, books and documents and to convene meetings with bank officials; authorities stated no problems encountered in getting access to books or systems. - RBI requires inclusion of counterparty risk including potential future exposure for regulatory capital calculation; no specific requirement in regulations that counterparty risk and potential future exposure be included in the credit management framework. - Credit information and documentation - Banks required to obtain financial statements from borrowers as a matter of practice. - Credit information sharing system requires participating banks to verify exposures exceeding Rs 25 lakhs before granting loans. - Assessment and recommendations - Assessment: Compliant - Comments: - No explicit RBI requirement that major credit risk exposures exceeding a certain amount or percentage of capital be decided by senior management, although in practice most banks have such requirements in credit policies. - No specific requirement that potential future exposure be included in credit management strategies or policies. - Recommendation: With increased use of credit risk models, RBI should consider requiring banks to have a comprehensive model validation policy approved by the Board (also referenced in CP 7). This applies to banks intending to apply Basel II advanced approaches and to standardized approach banks using models for pricing or internal management. ### Principle 9 — Problem assets, provisions, and reserves - Policy and classification framework - Banks required to establish policies for identification and management of nonperforming assets (NPA) and provisioning; policies should include regular review of NPAs and management reporting to the Board. Board-approved policies for write offs also required. - Two mandatory prudential guidelines for commercial banks: - Income recognition, asset classification and provisioning pertaining to the advances portfolio. - Classification & valuation of the investment portfolio. - All banks required to classify loan and investment assets as standard (performing) or nonperforming assets. Assets are classified as NPA when amounts are due for 90 days or more or, if in the view of the banks the recovery prospects are weak. - RBI norms set classification of NPAs as sub standard, doubtful and loss assets depending on ageing; norms specify required specific provisions taking into account potential threat to recovery. - Standard or performing assets require a provision between 0.40 percent and 2 percent to cover expected losses. - When computing NPAs, value of collateral is not deducted from balance outstanding. - RBI norms are minimum requirements; banks may voluntarily make specific provisions at higher rates provided Board approval and consistent application. - Floating provisions - Boards should lay out approved policies regarding “floating provisions.” Floating provisions can only be used for contingencies under extraordinary circumstances for making specific provisions in impaired accounts after Board approval and prior permission of the RBI. Board must specify what circumstances will be considered extraordinary. - At time of assessment, vast majority of banks held provisions above the minimum requirements of the RBI. - Provisioning requirement table (as presented in source) - The provisioning requirement outlined in the MC are as follows: - Standard assets Substandard assets Doubtful < 3 years Doubtful > 3 years *Source: _cr13267 - 2. A more systematic approach to critical review of host country supervisory* ### 0.40 percent - 2 ### _cr13267 - 0.40 percent - 2 ### Provisioning framework and countercyclical buffer - Banks are required to respect a Provisioning Coverage Ratio (PCR) of not less than 70 percent. - The PCR is the ratio of provisioning (specific and floating) to gross NPA and indicates the extent of funds a bank has kept aside to cover loan losses. - The positive surplus resulting from provisions under the 70 percent PCR as compared to the NPA provisions should be recorded and disclosed in an account “countercyclical provisioning buffer.” - The countercyclical provisioning buffer will only be allowed to be used for making specific provisions for NPAs during periods of system-wide downturn, to be determined by the RBI. - Examples of provisioning outcomes stated in the source: - 0.40 percent - 2 percent of outstanding amount irrespective of the Net Realizible Value (NRV) of the security - 15 percent - 25 percent of outstanding amount irrespective of the NRV of the security - 100 percent of the unsecured portion plus 25 to 40 percent of the NRV of the tangible security - 100 percent of the outstanding irrespective of the NRV of the tangible security ### Supervisory responsibilities, on‑site examination and audit - It is the primary responsibility of the bank’s management to ensure adequate provisions as per prudential requirements are made. - Bank auditors certify the appropriateness of asset classification and the adequacy of provisions as per RBI norms; RBI receives the annual long form audit report to analyze auditors’ work. - During the AFI, RBI examiners assess adequacy of provisions; coverage ratio targets for examination samples: - private sector banks and foreign banks: 60 percent - public sector banks: 30 percent - Examiners review provisioning and write off procedures, and systems and procedures for early identification of problem assets. - For inspection work, the assessors concluded that the scope and depth of onsite examiners’ work is adequate. - RBI examiners analyze and assess the integrity of management information systems aggregating exposures to individual and group counterparties during the AFI. ### Accounting and provisioning for off‑balance sheet and derivatives exposures - RBI guidelines include specific provisioning requirements for derivatives exposures (paragraph 5.9.12 of Part A of the Prudential Norms on Income Recognition, Asset Classification and Provisioning pertaining to Advances). - Accounting standard AS 29 “Contingent Liabilities and Provisioning” (mandatory for all commercial banks in India) requires recording of provisions for contingent liabilities likely to result in a loss; banks must provide where a loss on off balance sheet commitment or exposure is anticipated. ### Valuation of collateral and conservatism in realizable value - Realizable value of security must be assessed by an expert valuer when the security is above Rs 5 crore. - Realizable values are subject to haircuts depending upon the period of delinquency (MC paragraph 5.3). - When the realizable value is less than 10 percent of the exposure, it has to be ignored (MC paragraph 4.2.9 ii). - Paragraph 5.3 of the MC requires that immovable property collateral must be valued once in three years by expert valuers appointed as per Board guidelines. - Prudential guidelines recognize only tangible security and do not allow intangible security such as guarantees, comfort letters, etc. ### Asset classification, restructuring and early intervention - A NPA is a loan or advance where interest and/or installment of principal remain overdue for a period of more than 90 days (MC paragraph 2.1). - Overdraft accounts are treated as “out of order” if the outstanding balance remains continuously in excess of the sanctioned limit or drawing power (paragraph 2.2 of the MC). - If recovery prospects are weak, advances and/or investments should be classified as NPA. - Investments are classified as nonperforming if amounts due have not been collected within 90 days after the due date. - Banks are required to designate a time limit for overdue accounts and determine a threshold for active intervention well before the account becomes NPA; all accounts must be put on a list for early follow up and time bound action. - Banks must track migration of borrowers from one rating scale to another on an ongoing basis. - RBI Circular of 10 June 2010 “Calendar of Reviews” requires a Position report, giving details of NPAs and recovery, to be placed on the Board’s agenda at every meeting. - Banks must submit a review of all borrowers’ accounts classified as substandard, doubtful or loss where amount outstanding is Rs 1 crore and above; the report should cover deficiencies observed and systemic controls required for prevention of NPAs. - Guidelines on management of Credit risk (October 12, 2002) require loan review/credit audit mechanism for large accounts within 3-6 months of sanctioning as on existing accounts. - “Prudential Guidelines on Restructuring of Advances” state that refinancing a loan on the verge of being classified as NPA will be viewed adversely and categorized as ever-greening; restructuring should not lead to improved classification unless appropriate provisions are made against the net present value of the loss. ### Reporting and monitoring - Asset quality is monitored on a quarterly basis through submission of prudential returns. - Annual financial statements must disclose movements in provisions and nonperforming assets. - Offsite prudential returns report various sectoral and geographical concentrations; significant movements at system level inform policy responses and significant bank-level variations are taken up with respective banks. - Banks are required to report their Top 20 exposures on a monthly basis. - For derivatives, exposures are calculated using the current exposure method. ### Regulatory powers and use of directions - Under Section 35A of the BR Act, the RBI can issue directions to all banks or to individual banks; these directions can include, inter alia, higher provisions. - Assessors were informed of specific instances where authorities asked for higher provisions; in general banks adjust on request without need for a direction. - RBI has the power to require additional provisioning or higher capital by issuing a direction to a particular bank or to banks in general in accordance with Section 35A of the BR Act. ### Large exposure limits and concentration risk - RBI requires banks to develop policies to define a “group of connected counterparties” guided by “effective control” and “communality of management”; however, assessors found limited reference to Indian accounting standards in MC or guidance and concluded verification of connected counterparties during AFI is too limited. - Circular “Risk Management in Bank” (7 October 1999) prescribes large exposure limits: - single borrower: 15 percent of bank’s capital - group of borrowers: 40 percent of bank’s capital - these limits apply at solo and consolidated banking group level - both limits can be exceeded by 5 percent and 10 percent respectively for infrastructure projects - board may increase single and group limits by additional 5 percent in exceptional temporary circumstances subject to borrower consenting to additional disclosures in the Annual Report - the sum of the large exposure limit must be set below 800 percent of capital funds - With effect from 29 May 2008, exposure limit in respect of a single borrower raised to 25 percent of capital funds for oil companies that have issued Oil bonds; banks may in exceptional circumstances consider enhancement up to a further 5 percent. - Lower prudential limits for exposures to Nonbank Financial Companies: - single NBFC: 10 percent of capital funds - single NBFC-AFC (Asset Financing Companies): 15 percent of capital funds - banks may assume exposures to single NBFC / NBFC-AFC up to 15 percent or 20 percent respectively if the excess is on account of funds on-lent by the NBFC/NBFC-AFC to the infrastructure sector. - Exposures of banks to Infrastructure Finance Companies (IFC) should not exceed 15 percent of capital funds as per last audited balance sheet, with provision to increase to 20 percent if on account of funds on-lent by the IFCs to the infrastructure sector. - Aggregate exposure of banks to the capital markets in all forms restricted to 40 percent of net worth as of March 31 of the previous year of the bank; within this ceiling, direct investment in shares, convertible bonds and debentures, units of equity oriented equity funds and all exposures to Venture Capital Funds should not exceed 20 percent of net worth. - These limits are monitored during AFI and via monthly offsite prudential returns; exposures include on balance sheet and off balance sheet exposures. ### Assessment and recommendations on large exposures - Assessment: Materially Noncompliant. - Key comments: - More detailed requirements and guidance on criteria for determination of “connected exposures” are required (for example, include cross‑guarantees or financial interdependency). - RBI examiners should verify definition of connected parties in more depth during AFI. - The group large exposure limit of 40 percent (exceptionally 50 percent for infrastructure) is significantly higher than the large exposure limit of 25 percent considered good international practice and could allow default of a consolidated borrower to cause a serious loss of capital. - Assessors recognize need to balance financial development and financial stability but consider the aggregate limit significantly out of line with international good practice. ### Exposures to related parties (summary of issues) - A definition of related parties exists but excludes shareholders, promoters and officers of the bank. - With limited exception of loans for personal use (Master Circular – Loans and Advances – Statutory and Other Restrictions, Paragraphs 2.1.2 and 2.2.1), directors (or firms with which the director is interested as partner, manager, employee, or guarantor or in which he holds a substantial interest) are not allowed under the specified provisions. *Source: _cr13267 - 0.40 percent - 2* ### Section 20(1) of the BR Act to obtain credit from their bank The term “director” is also ### _cr13267 - Section 20(1) of the BR Act to obtain credit from their bank The term “director” is also ### Related-party lending and corporate governance (Principle 11) - Legal/regulatory features: - Section 20(1) of the BR Act: general prohibition on lending to directors; “director” defined broadly to include for example people on advisory Boards. - By RBI regulation, loans to subsidiaries or joint ventures must be on an arms-length basis; a law change is being proposed to require by explicit provision in law that loans to subsidiaries and joint ventures be on an arms-length basis. - Identified limitations and gaps: - The failure of the definition of related parties to include shareholders or promoters is a gap that should be remedied. - Where promoters and other principal shareholders do not have director representation, there is no requirement that loans to them, or companies affiliated with them, be proscribed or subject to an explicit arms length review. - EC 3–EC 7: multiple supervisory/board approval and reporting requirements have limited applicability because loans to related parties are granted to a limited extent (personal use in the case of directors); specifics include: - Loans to relatives of directors are required to be reviewed by the Board if they exceed 2.5 million INR (with the director not participating in the sanction); loans below that level can be approved through normal bank approval processes but should then be reported to the Board. - Restrictions on participation in sanction processes, capital deduction/collateralization of related-party exposures, requirements for banks to identify/monitor/report related-party exposures, and supervisor review of aggregate exposures all have limited applicability for the same reasons described in EC 3. - Assessment: Largely Compliant - Comments / recommended actions: - Remedy the definition gap to include shareholders or promoters. - Develop regulatory approaches for excluding related-party lending from capital or for taking other adjustment steps. - Implement the proposed law change and strengthen regulatory provisions to ensure arms-length relationships with subsidiaries (a regulatory provision currently exists). *Source: IMF assessment text provided.* ### Country and transfer risks (Principle 12) - Regulatory framework and requirements: - RBI circular “Risk Management systems in Banks – Guidelines on country risk management” issued on 19 February 2003. - 2002 Guidance Note on Credit Risk includes Chapter 7 dedicated to Country risk. - Banks must formulate well documented and clearly defined Country Risk Management (CRM) policies, approved by their Boards, covering domestic and foreign operations and direct and indirect country risk. - For each country where the bank’s net funded exposure is 2 per cent or more of its total assets, the bank is required to formulate the Country Risk Management Policy, including contingency plans and exit strategies. - Banks required to implement systems/procedures approved by the Board to handle significant changes in country conditions. - Reporting, monitoring, and limits: - As part of offsite monitoring, banks report exposures to all countries in excess of 1 percent of total assets. - Banks are required to set country exposure limits as a percentage of regulatory capital (Tier 1 and Tier 2); limits are the responsibility of the Board and should be reviewed at least once a year. - During the AFI, RBI examiners assess banks’ information systems and country risk procedures. - At the assessment date, Indian banks had an average of 15 percent to 18 percent of foreign exposures, mainly to the United Kingdom, the Middle East, Europe, and the United States. - Provisioning: - RBI prescribed provisioning requirement on net funded country exposures on a graded scale ranging from 0.25 to hundred percent, following the seven grade risk classification of the Export Credit Guarantee Corporation of India (ECGC). - Provisions to be made when the bank’s net funded exposure is two percent or more of its total assets. - Banks’ provisioning levels may be lower for short term exposures i.e., less than 180 days. - Country risk provisions are in addition to provisions required by asset classification of the asset. - Review frequency: - Banks are required to review country risk exposures on a quarterly basis. - Assessment: Compliant *Source: IMF assessment text provided.* ### Market risk (Principle 13) - Structural and supervisory features: - All Indian commercial banks have relatively limited trading books, on average less than 10 percent of total assets. - RBI guidance note on market risk management issued in October 2002; requires Board-approved market risk policies, prudential risk limits, review mechanisms, reporting and auditing systems, consolidated exposure treatment, and articulated risk measurement systems. - Banks are not allowed to take positions in commodities (Section 6 of the BR Act); gold positions are treated as FX in accordance with the Basel guidelines on market risk. - Market risk capital: banks required to hold regulatory capital in accordance with the standardized approach; RBI has advised banks it will allow the use of the Internal Models approach (IMA) after regulatory approval. - Valuation, stress testing, and controls: - Investment portfolio classified into Held to maturity, Available for Sale and Held for Trading; Held for Trading and Available for sale positions should be marked-to-market periodically. - Valuation methods must capture concentrations, less liquid positions and stale positions; reflected in provisions (see “Prudential Guidelines on Capital Adequacy” paragraph 8.7.1). - RBI released detailed supervisory expectations on stress testing and scenario analysis (Annexure V of the Guidance note) and Circular “Guidelines on stress testing” issued on June 26, 2007. - Assessors reviewed inspection reports and concluded supervisory depth and scope were adequate. - Independent rates and middle office: - AC 1: market rates used for marking exposures and models must be sourced independently from the dealing room; independent middle office should take responsibility if established. - Assessment: Compliant *Source: IMF assessment text provided.* ### Liquidity risk (Principle 14) - Framework and evolution: - RBI issued liquidity risk management guidelines, refined in 1999, 2007, and 2010. - RBI monitors statutory reserve requirements – specifically, the cash reserve ratio and the statutory liquidity ratio. - Governance and committees: - Boards take overall responsibility for risk management and set liquidity risk limits; Asset-Liability Committee (ALCO) includes senior management and the CEO and is responsible for adherence to limits and balance sheet planning. - Management Committee of the Board (or other specific Committee) oversees implementation and reviews functioning. - Stress testing, limits, and contingency: - Banks required to undertake portfolio-wide liquidity stress tests and scenario analyses under normal situation, a bank-specific crisis, and a market-crisis scenario (requirements established in Circular dated June 26, 2007). - Inspectors review diversification of funding sources through top 10 or 20 sources of funding for each bank. - Banks required to establish aggregate and individual gap limits for each currency and receive RBI approval for such limits. - Banks required to manage foreign currency liquidity and interest rate risk via maturity and position analysis and fixed net open positions approved by the RBI. - Banks are required to prepare Contingency Funding Plans (blueprint for asset sales, market access, alternate funding sources, restructuring maturity/composition of assets and liabilities); these are reviewed during the AFI process. - Supervisory observations: - Ensuring consistent and rigorous reviews by inspectors would be improved with a concentrated effort to bring inspectors together with central office to discuss findings; review of contingency funding plans cited as an example. - AC 1: stress testing for foreign currency liquidity for large banks active in the foreign exchange market has been prescribed by the RBI. - Assessment: Compliant - Comments: - RBI has a very conservative framework for liquidity risk management; AFI reviews include critical reviews of duration gap analysis and integrity of data systems supporting liquidity metrics. *Source: IMF assessment text provided.* ### Operational risk (Principle 15) - Regulatory guidance and board responsibilities: - RBI issued a detailed guidance note on operational risk in 2005 outlining Board and senior management roles, policy/strategy, identification/assessment/monitoring, independent internal audit evaluation, and capital allocation. - Board responsibilities include approving an appropriate operational risk management framework, providing senior management direction, and reviewing the framework periodically. - Framework should define operational risk, appetite/tolerance, and key processes to manage operational risk; also address risks from new products/activities/systems. - Supervision and business continuity: - Adequacy of the framework assessed during onsite inspections; assessors reviewed inspection reports and found scope and depth adequate. - Circular on Business Continuity plans issued on 15 April 2005: banks must have contingency and business continuity plans, stress tested annually; plans to consider plausible scenarios, be reviewed periodically, and tested. - Information security and outsourcing: - Guidance requires appropriate information security function and systems development; RBI employs examiners specializing in IT risks. - RBI guidelines on outsourcing issued on 3 November 2006 (“Guidelines on Managing Risks and Code of Conduct in Outsourcing Financial Services by banks”) require comprehensive outsourcing policies approved by the Board, due diligence, parameters for material outsourcing, contingency plans for critical activities, and monitoring/review systems. - Material outsourcing arrangements are those which, if disrupted, could significantly impact business operations, reputation or profitability. - Reporting of operational events and fraud: - No legal/regulatory requirement for banks to inform the RBI of any adverse developments in operational risk. - Frauds amounting to more than Rs 1 lakh are to be reported to the RBI on a case by case basis per paragraph 3 of the Master Circular “Frauds – Classification and Reporting.” Frauds of less than Rs 1 lakh are to be reported to the RBI in consolidated form, by category. - RBI has a mechanism to monitor frauds to identify outlier banks; other adverse developments are generally raised as part of quarterly meetings with banks as outlined in CP 20. - Scope and group-level application: - AC 1: the 2005 guidance note scope is at the banking group level; approach depends on size, sophistication, nature and complexity of activities. - Assessment: Largely compliant - Comments and implementation timeline: - No legal/regulatory requirement to inform RBI of adverse operational risk developments, but in practice quarterly meetings ensure RBI is informed within maximum three months after the facts. - RBI set up a Working Group in 2010 on Information Security, Electronic Banking, Technology Risk Management and Cyber Frauds; recommendations covered nine areas: IT Governance, Information Security, IS Audit, IT Operations, IT Services Outsourcing, Cyber Fraud, Business Continuity Planning, Customer Awareness programs and Legal aspects. - RBI required banks to conduct a formal gap analysis and establish a time-bound action plan; basic organizational frameworks and policies were required to be in place by October 31, 2011; remaining guidelines to be implemented by April 2012 unless a longer time-frame indicated. Some provisions are recommendatory and implementation is at banks’ discretion. - The requirements in the Circular were not in place at the assessment date but implementation is expected to strengthen operational risk management. *Source: IMF assessment text provided.* ### Interest rate risk in the banking book (Principle 16) - ICAAP and supervisory thresholds: - “Supervisory Review Process under the New Capital Adequacy Framework – Guidelines for Pillar II” issued on 26 March, 2008 requires banks to have an ICAAP covering interest rate risk in the banking book (IRRBB). - Banks may decide, with Board approval, on appropriate level of IRRBB considering capital, management skills, and re-balancing ability. - A level of interest rate risk that generates a drop in the market value of equity (MVE) of more than 20 percent with an interest rate shock of 200 basis points will be treated as excessive; such banks will be required by the RBI to hold additional capital against IRRBB as determined during the SREP. - Banks with IRRBB exposure equivalent to less than 20 percent drop in MVE may also be required to hold additional capital if RBI considers the level of interest rate risk high relative to capital level or quality of interest rate risk management. - At the assessment date, no banks were holding a capital surcharge imposed by the RBI for IRRBB. - Exact capital add-on, if necessary, decided by the RBI as part of the SREP. - Measurement and model requirements: - EC 2: banks were initially required to use Traditional Gap Analysis (earnings perspective); in November 2010 banks were advised to adopt Duration Gap Analysis (market value of equity perspective) by April 2011 (“Guidelines on Banks Asset and Liability Management Framework – Interest Rate” issued on 4 November 2010). - Guidelines include model validation requirements; compliance assessed by RBI interest rate specialists during AFI. - Risk identification and stress testing: - EC 3: banks must identify risks from changing interest rates on on-balance and off-balance sheet exposures from short-term and long-term perspectives, including parallel shocks, yield curve twists, yield curve inversions, basis risk, and other scenarios. - Banks must demonstrate validity of assumptions about behavioral characteristics of non-maturity deposits and other assets/liabilities, especially those with embedded optionality, to RBI examiners. - Stress testing and scenario analysis should be used; in practice authorities stated most banks only assess impact of parallel shifts in the yield curve. - RBI issued Circular “Guidelines on Stress testing” on 26 June 2007. - Reporting: - AC 1: banks submit a monthly prudential return on interest rate sensitivity for exposures in local currency as well as foreign currency; half yearly consolidated prudential returns also include measures on interest rate sensitivity. *Source: IMF assessment text provided.* *Source: IMF assessment text provided.* ### Section 27.2 of the BR Act, the RBI has the power to request any information from banks. ### _cr13267 - Section 27.2 of the BR Act, the RBI has the power to request any information from banks. ### IRRBB, AFI, ICAAP and supervisory review - AC 2: IRRBB is an essential component of the AFI and the RBI has specialized examiners who assess the management of IRRBB in banks. - Banks confirmed the depth and scope of the reviews to the assessors; assessors also reviewed an inspection report for this area. - IRRBB is part of the ICAAP which banks must submit yearly to the RBI in accordance with the guidelines in “Supervisory Review Process under the New Capital Adequacy Framework – Guidelines for Pillar 2” issued on 26 March 2008. - From discussions with banks, the assessors were informed that an active dialogue between the bank and the RBI examiners as part of the SREP is not standard supervisory practice but is conducted in specific instances cases. - AC 3: The RBI issued the Circular “Guidelines on Stress testing” on 26 June 2007. The Circular requires that Board and senior management regularly review the results of scenario analyses and stress tests, including the major assumptions that underpin them. The guidelines include an example for the stress testing of IRRBB. - AC 4: The banks’ Board has overall responsibility for the management of risks and should decide the risk management policy of the bank and set limits for liquidity, interest rate, foreign exchange and equity price risks. - The Asset - Liability Committee (ALCO) consisting of the bank's senior management including CEO is responsible for ensuring adherence to the limits set by the Board as well as for deciding the business strategy of the bank (on the assets and liabilities sides) in line with the bank’s risk tolerance. - The 1999 Circular on Risk Management Systems in banks requires “a separate risk management framework independent of operational departments and with clear delineation of levels of responsibility for the management of risk” (Introduction, bullet vii). - Assessment: Compliant ### Internal control and audit (Principle 17) — framework, oversight and gaps - Legal and governance framework: - EC 1: Section 10B of the BR Act established the responsibility of a full-time Chairman of the Board. - RBI established a Fit and Proper Test for directors as updated in a May 23, 2011 Circular. - Corporate governance guidance issued in a June 4, 2002 circular. - No explicit requirement for the RBI to be notified of material developments concerning a fit and proper test for existing directors (as indicated in the 2009 Self Assessment). - Internal control expectations and delegation: - EC 2: 11/1/96 Circular on Internal Control and Inspection/Audit Systems of Banks established expected internal control structure. - 1999 Circular (“Risk Management in Banks”) sets guidelines for delegation of powers to make loans; authorization for large loans requires committee approval (large loan definition by the bank). - EC 3: 2002 consultative group review set Board functions including delegating powers and providing organizational and financial controls. - EC 4: BR Act Section 36 AA provides the RBI with authority to remove officers of a bank; discretion used in practice for private sector banks; not applicable to public banks. - Separation of functions and inspection monitoring: - EC 5: A Master Circular provides for clear functional separation of (1) trading; (2) settlement, monitoring, and control; and (3) accounting. This is monitored through the inspection process. - Skills, staffing and compliance: - Skills assessed broadly in the Inspection process; adequacy of resources considered within CAMELS rating process. - AFI focuses on effectiveness of functions like audit and compliance rather than headcount alone. - RBI indicated there is not a specific focus on reviewing the appropriate balance of skills and resources of back office/control functions relative to front office, though normal rotation of staff is expected to smooth skills. - Need for adequate staffing in Compliance explicitly referenced in a 2006 Circular. - Compliance and internal audit guidance: - EC 6: Guidelines for a Compliance function issued on April 20, 2007; adherence reviewed during inspections. Chief Compliance Officer must be sufficiently senior, reporting to senior management, with right of direct access to the Board. - EC 7: Guidance Note dated December 27, 2002 provides guidelines on ensuring a risk-based internal audit function exists at banking companies. Effectiveness of Internal Audit assessed as part of the AFI. - EC 8: Head of Internal Audit typically at General Manager level with reporting to the Board’s Audit Committee; for FBOs, reporting expectations include dotted reporting to firm-wide head of internal audit. - Outsourcing and internal audit scope: - Circulars dated December 11, 2008 and November 3, 2006 concern outsourcing and off-shore service providers. - Banking companies must ensure relevant off-shore supervisor would not object to RBI inspection visits or visits of the bank’s internal or external auditors. - Internal Audit can inspect the outsourcing entity; RBI has inspected outsourcing entities within India. - Core activities such as internal audit cannot be outsourced, though assessors were informed a particular bank outsourced specific internal audit assignments requiring specialized expertise (e.g., internal model validation). Back office operations where position taking is not involved can be outsourced. - Assessment: Largely Compliant - Comments — areas for improvement: - Ensuring updates on developments affecting the fit and proper test for existing directors are received. - Ensuring a strong focus in the AFI process on assessing the quantity of people and skill level of people in risk management and control functions. ### Abuse of financial services, AML/CFT and KYC (Principle 18) — laws, supervisory practice, and guidelines - Legal framework and supervisory role: - EC 1: The Prevention of Money Laundering Act 2002 (PMLA) is core to India’s anti-money laundering framework; Section 54 defines powers and responsibilities of competent authorities. - PMLA, Rules and regulatory guidelines foresee specific roles for RBI, SEBI, IRDA and FIU-IND to explicitly monitor commercial banks’ compliance with AML/CFT obligations. - RBI has regulatory powers and supervisory capacity and includes AML/CFT compliance as part of its inspection process. - Master Circular on KYC/AML/CFT: - RBI issued Master Circular “Know your Customer (KYC) norms/ Anti Money Laundering (AML) standards / Combating of Financing of Terrorism (CFT) /Obligations of banks under PMLA” on 1 July 2010; consolidation of mandatory guidelines issued up to June 30, 2010. - Under these guidelines and the PMLA, all commercial banks must have a policy framework on KYC covering customer acceptance policies, customer identification procedures, monitoring of transactions and risk management. - Supervisory verification and implementation status: - EC 2: RBI examiners ensure during the AFI that banks comply with AML/KYC policies. A 2006 RBI survey found all banks had implemented KYC/AML policies with Board approval and enforcement at branch level. Inspection reports reviewed by assessors noted many critical weaknesses; KYC/AML inspections have only started recently and full compliance cannot yet be expected. - EC 3: Suspicious transactions are reported only to the Financial Intelligence Unit-IND (FIU-IND). RBI has access to STRs during AFI. - Frauds amounting to more than Rs 1 lakh are to be reported to the RBI on a case by case basis per paragraph 3 of the Master Circular “Frauds – Classification and Reporting.” Frauds of less than Rs 1 lakh are due to be reported to the RBI in consolidated form, by category. - RBI maintains a database of frauds and modus operandi and shares information with banks to prevent such frauds. - KYC Guidelines — four sections summarized: - EC 4: The Master Circular includes: - Bank’s Customer Acceptance Policy: banks must not open accounts in fictitious names; apply risk-based parameters and guidance for low risk customers. - Customer Identification Procedures: procedures at different stages; reasonable steps to identify beneficial owners; accept clients only after that process is completed. - Monitoring of transactions: paragraph 2.8 requires special attention to complex, unusual large transactions, unusual patterns, cash transactions inconsistent with normal activity, and very high turnover relative to balance maintained; ongoing due diligence needed. - Risk Management: paragraph 2.10 details Board responsibility to ensure effective KYC policies and outlines roles of internal audit and compliance. - FATF/APG mutual assessment findings: - Mutual assessment report “Anti Money Laundering and Combating the Financing of Terrorism” by the FATF/Asia Pacific Group issued on 25 June 2010 reviewed compliance of the Circular with the PMLA and international best practices. - Recommendation 5 on Client Identification Program is rated partially compliant. - FATF/APG comments: circular silent on need to revisit customer due diligence when suspicions arise; lack of guidance on identifying ultimate beneficial owner; issues with client accounts opened by professional intermediaries and client confidentiality; circular did not require override of low risk procedures when suspicions exist; suggested authorities require banks to consider filing a STR when institution can no longer be satisfied it knows the true identity of the customer. - Politically exposed persons (PEP): - Specific requirements detailed in paragraph 2.5 (v) of the Master Circular: decision to enter into relationship with PEPs must be taken at senior level and intensive due diligence applied; scope extends to relatives and family members of PEPs. - Correspondent banking and shell banks: - EC 5: Banks required to gather information about correspondent banks (paragraph 2.15): management, major activities, AML/CFT compliance, purpose of account opening, identity of third party entities, and regulatory/supervisory framework of correspondent/respondent’s country. - AML Report rated Recommendation 7 on Correspondent banking as largely compliant. - Shell banks are not permitted in India; paragraph 2.15 (b) advises banks not to enter relationships with shell banks. AML Report rated Recommendation 18 on Shell Banks in India as largely compliant. - Internal audit, reporting lines and responsibilities: - EC 6: RBI examiners verify compliance with KYC circular during AFI; internal and concurrent auditors must check and verify branch-level KYC application and report gaps. Audit Committee must be informed quarterly (paragraph 2.10). Audit reports must be made available to RBI on request or during inspections. - EC 7: KYC guidelines issued under Section 35 A of the BR Act; RBI has extensive powers to address noncompliance. - EC 8: Banks should appoint a Principal Officer (PO) from Senior Management as contact point for AML issues as per paragraph 2.18; PO responsible for monitoring and reporting transactions and liaising with enforcement agencies, banks and other institutions. - PO responsible for timely submission of CTR, STR and reporting counterfeit notes and transactions involving receipt by nonprofit organizations of value more than Rs 10 lakh or its equivalent in foreign currency to FIU-IND. - PO role need not be full time; generally performed by Compliance or Legal officer. - Banks required to put in place adequate screening mechanisms as part of recruitment (paragraph 2.12 c). - Ongoing employee training programs required with different focus for frontline staff, compliance staff and staff dealing with new customers (paragraph 2.12 b). - MIS, reporting protection and information sharing: - EC 9: RBI analyses and assesses banks’ MIS systems during AFI and reviews AML policies and procedures to ensure reporting mechanisms for abuse are in place. - EC 10: Section 14 of the PMLA 2002 states banking companies or their officials would not be liable to civil proceedings for furnishing information to the appropriate authority under the Act. AML report rated India Largely Compliant on Recommendation 14 – Protection and no tipping off. - EC 11: There is no explicit prohibition on the RBI from sharing information relating to suspect and actual criminal activities with relevant judicial authorities as well as with the FIU. The secrecy provisions in the BR Act do not apply in this particular case as *Source: _cr13267 - Section 27.2 of the BR Act, the RBI has the power to request any information from banks.* ### Section 71 of the PMLA has an overriding effect in case of inconsistencies with other law ### _cr13267 - Section 71 of the PMLA has an overriding effect in case of inconsistencies with other law ### Section 71 of the PMLA and AML/CTF cooperation - EC 12: Section 56 (1b) of the PMLA 2002 permits the government of India to enter into agreements with foreign governments for exchange of information to prevent offences under the Act or corresponding foreign laws. - The RBI has entered into MOUs with China and Dubai; these MOUs do not contain specific provisions with regard to the abuse of the financial system. - The RBI has not yet had to inform the FIU directly of any concerns. - AC 1: Not applicable as this is done by the FIU-IND. - Assessment: Largely Compliant - Comments: - Issues within RBI responsibility raised in the Mutual Assessment report “Anti Money Laundering and Combating the Financing of Terrorism” have been addressed. - RBI regulatory framework for AML generally complies with the essential criteria of this Core Principle. - Inspection reports reviewed noted many critical weaknesses in AML/KYC areas; KYC/AML inspections have only started recently and full compliance is not yet expected. ### Principle 19 — Supervisory approach - Core description: - RBI guidelines on risk management systems and guidance notes on credit, market, and operational risk exist. - Quarterly risk profile template required from banks’ risk management areas. - AFI inspectors review bank risks and risk management. - Monitoring activities year-round determine AFI priorities and focus. - Macro-prudential indicators compiled, including aggregated micro-prudential indicators and macro-economic indicators. - Periodic contact with nonbank financial company supervisors exists; opportunities for improvement noted. - OSMOS monitoring system analyzes risks quarterly for individual banks and peer comparisons. - Compliance with prudential regulations and legal requirements evaluated during AFI. - RBI expects notification of substantive changes from banks; clear guidance exists for fraud reporting but not for business strategy or changes in directors/Senior Management (other than the CEO). - RBI has a well-developed information system for prudential information. - AC 1: Some forward-looking risk reviews exist (stress tests, concentration reviews); more consistent review and validation of risk management models could be done. - Assessment: Largely Compliant - Comments and recommendations: - As of 2011, 645 people work in the Department of Banking Supervision; the number declined from 729 two years earlier. - Given Basel process demands and move to more continuous supervision for twelve largest banking companies, staffing should be reviewed to ensure appropriate quantity and quality. - Re-assess practice of rotating staff across RBI departments to build specialized supervisory expertise; maintain bulk of supervisory/regulatory staff in bank supervision/regulation areas. - Increase focus on consolidated risks of banking groups; consider methodology for rating banking companies to reflect issues at nonbanking subsidiaries. - Issue clearer guidance on need for banking groups to provide updates between AFIs. - Ensure review and validation of models used for internal risk management even if not used for regulatory capital. ### Principle 20 — Supervisory techniques - Core description: - RBI uses off-site monitoring and on-site inspections to assess banks; on-site inspections evaluate Board and top management oversight. - Section 35 of the BR Act authorizes RBI inspections. AFI planning requests extensive pre-AFI information including audit reports. - AFIs performed by regional offices; consistency across regional inspectors is a concern. - AFIs include extensive review of credit files and testing of automated systems. Loan portfolio review guidance: 60 percent for private and foreign banks; 30 percent for public banks. - Nonbank subsidiaries receive some information flow but are not subject to transaction testing processes applicable to banks. - Models used for risk management purposes are not required to be consistently reviewed and validated. - Inspection reports enumerate supervisory concerns; follow-up includes senior management consultation, action plans, and monitoring. - OSMOS supports quarterly risk analysis and prioritization; structured interaction exists between Inspection Officer and Relationship Officer. - Quarterly discussions held with senior management; no similar regular interaction with directors (RBI directors on Boards of public banks provide a report every two months). - Quality of management assessed within CAMELS; M accounts for 18 percent of composite rating. - Internal audit, concurrent audit, statutory audit, and Audit Committee effectiveness reviewed during AFI. - Extensive inspection report and separate letter on major findings with timeframes provided. - Assessment: Largely Compliant - Principal improvement needs (extracted): - Provide a regular forum for regional office inspectors and central office to review findings and ensure consistency, especially when introducing new supervisory approaches. - More intensive review of nonbank subsidiaries. - Improved monitoring of foreign operations via better information flow from overseas supervisors and/or more overseas inspections. - Ensure critical review and validation of risk management models not yet used for regulatory capital. - Develop structured interaction throughout the year with directors of private sector banks. - Ongoing developments: - Steering Group began a year-long review in April 2011 led by a deputy governor to consider supervisory process modifications for the largest banking groups. - DBS announced restructuring to move off-site monitoring closer to on-site inspection. - RBI will establish a new supervisory regime for the largest 12 banking companies designated as systemically important: supervisory responsibility moved from regional offices to central office; shift from once-a-year to more continuous supervision with targeted reviews. ### Principle 21 — Supervisory reporting - Core description: - Section 27 of the BR Act requires monthly returns showing assets and liabilities; RBI may direct banks to provide statements and information. - BSD’s supervisory strategy includes fortnightly, monthly, quarterly, and biannual returns. - For banking companies on a solo basis there are 23 prudential returns with varying periodicity. - Consolidated prudential returns collected on a 6 monthly basis. - Overseas banking subsidiaries submit separate quarterly returns. - Financial conglomerates are subject to quarterly prudential reporting focused on intra-group transactions; RBI has identified 6 financial conglomerates with a banking company. - Financial statements prepared using ICAI accounting standards; Section 29 prescribes format; RBI issued detailed instructions on disclosures. - RBI issues valuation rules where gaps exist in accounting framework; prudential norms complement accounting standards for investment portfolio classification and provisioning and advances. - RBI analyzes prudential returns on solo and consolidated bases; aggregate reports include “Monthly Banking Outlook” and quarterly “Review of the Macro Prudential Indicators”. - Peer group analyses based on four broad peer groups and sub-peer groups; some offsite analysis at regional offices. - Section 27 allows RBI to request information from banks and supervised entities in a banking group; RBI cannot request information from affiliated but unregulated entities (see CP 24). - Quarterly “Regulated Institutions meeting” shares institution-specific concerns among RBI departments. - Section 35A and Section 35 give RBI powers to issue directions and access directors, officers, and employees. - No regulations assign specific senior management responsibilities for accuracy of returns; supervisory expectation that returns be signed off by a member of Senior Management (generally the compliance officer). - Submission of erroneous information leads to penalties under Section 46 (1) of the BR Act. - Section 30 (1B) allows RBI to direct a special audit; auditor must comply and report to RBI; expenses borne by the banking company (Section 30 -1C). - Appointment letter of external auditor contains roles and responsibilities; auditors provide findings to RBI per Section 30 (3). - Statutory auditors required to report frauds of Rs 1 crore and above not reported by banks and serious irregularities observed during audit. - Assessment: Largely Compliant - Comments: - RBI cannot require information from affiliated but unregulated entities of a banking group; a legal amendment has been proposed to address this. ### Principle 22 — Accounting and Disclosure - Core description: - RBI authority to hold bank management accountable for reliable financial record keeping and impose penalties or directions under Section 47A and Section 35A of the BR Act. - Section 30 (1A) mandates annual audit by external auditor pre-approved by RBI; external auditor certifies true and fair view under Section 30 (3). - Banks must use valuation rules by ICAI unless RBI lays out different rules; RBI has issued asset classification, provisioning norms, and collateral valuation norms. - Banks required to set up provisions for standard loans amounting to 0.25 percent to 2 percent. - Derivatives positive and negative replacement values do not have to be recorded on the balance sheet; unrealized losses and profits disclosed in notes. - RBI mandates additional disclosures in notes to annual accounts. - Section 30 (1-B) and Section 30 give RBI power to direct special audits and vary audit scope; RBI uses this power in practice. - Statutory auditors complete certifications covering internal control, balances, investments, advances, premises, other assets/liabilities, reserves and provisions, reserve requirements compliance, treasury operations, and income recognition, asset classification and provisioning norms. - Banks can appoint statutory auditor only with prior RBI approval (Section 30 1-A); RBI approves re-appointments and removals. - RBI may withdraw approval of external auditors when deficiencies identified. - Formats for financial statements prescribed under Section 29; Indian banks will converge to IFRS as from April 2013 onwards. - All commercial banks are listed and required to publish unaudited quarterly results; Section 31 requires publication of audited balance sheet and profit and loss accounts with auditors’ report. - RBI requires publication of annual accounts in a newspaper at bank’s principal office location and in abridged form elsewhere; Pillar III Basel II disclosures required. - MC “Disclosure in Financial Statements – Notes to accounts” lists disclosures including: - Capital Adequacy Ratio; Tier I capital ratio; Tier II capital ratio; Percentage of shareholding of the government of India in nationalized banks; Net NPL ratio; Amount of provision made toward NPLs and provisions for income-tax for the year; Amount of Subordinated debt raised as Tier II capital; Gross value of investments, provision for depreciation on investments and net value of investments within India and outside India; Interest income as percentage to working funds; Non-interest income as a percentage to working fund; Operating profit as a percentage to working funds; Return on assets; Business (deposits and advances) per employee; Profit per employee; Maturity pattern of certain assets and liabilities; Movement in NPLs; Foreign currency assets and liabilities. - RBI can issue directions under Section 35A for non-compliance with disclosure requirements; disclosures reviewed by RBI examiners during annual inspections. - RBI publishes Weekly Statistical Supplement and fortnightly Scheduled Bank’s statement of position; annual Report on Trend and Progress of Banking in India provides detailed analysis. - AC 1–AC 5: - RBI organizes seminars for auditors; senior audit profession members represented on RBI Central Board; Bank Audit Committee engages with audit profession. - No regular interaction between individual auditors and RBI examiners at institutional level reported. - No legal responsibility on auditors to report directly to RBI, but appointment letters require auditors to report serious irregularities and frauds above Rs. 100 lakhs. - Rotation/rest requirement: audit firm continuously associated for four years must rest for at least two years; branch auditor firms rested after continuous association for 5 years for minimum 2 years. - Banks required to have a disclosure policy per Master Circular paragraph 14.8. - RBI does not have explicit powers to access external auditors’ working papers; authorities stated RBI can request supporting material. - Assessment: Largely compliant - Comments and recommendations: - RBI lacks direct authority to rescind statutory auditor appointment, though it has withdrawn approval in past when deficiencies observed. - Financial statements based on ICAI standards, which are not internationally and widely accepted; convergence with IFRS scheduled from April 2013. - AS 30, 31 and 32 on financial instruments have not been notified and are not binding; RBI issues prudential guidelines to fill gaps. - RBI does not have access to external auditors’ working papers. - Recommendation: Increase interaction with external auditors. ### Principle 23 — Corrective and remedial powers of supervisors - Core description: - EC 1: Supervisory letters with major deficiencies issued to CEO after AFI; general time frame guidance (May 29, 2002 circular) alludes to one- to three-month timeframes; in practice timeframes often determined after interaction and may be six months or more. Progress monitored by Supervisory Relationship Officer; risk experts and Principal Inspecting Officer may be invited to monthly monitoring meetings. - EC 2: RBI powers for orderly resolution include closure, restructuring, or merger; central government may invoke certain resolution powers under Section 36AE for public interest reasons. - Voluntary amalgamation under Section 44A with shareholder approval. - Voluntary winding down under Section 44 if RBI certifies bank can pay debts as they accrue. - Under Section 45 RBI can apply to central government for moratorium and compulsory reconstitution/amalgamation; moratorium limits deposit withdrawals; no financial support provided but some regulatory forbearance may be exercised. - EC 3: Under Section 35A RBI can issue directives for remedial action; Section 46 allows penalty imposition; RBI imposed penalties on April 11, 2011 on 19 banks for derivatives regulation violations. Section 46.5 allows referral to courts. - EC 4: Section 22 (4) empowers RBI to cancel license except for public banks if conditions not met. Section 21 allows RBI to direct purposes of advances, margins, maximum amounts to entities, and rates/terms; reasons include preventing conduct detrimental to depositors or ensuring proper management. - Section 10 B allows RBI to appoint a new CEO of a problem private sector bank. - Section 36AB allows RBI to add one or more additional directors to strengthen private sector bank Boards. - EC 5: RBI has a prompt corrective regime with triggers tied to capital, NPAs, and ROAs. - If NPAs beyond established levels, RBI can issue directions (e.g., upgrade underwriting policies, reduce/stop lending). - If ROA falls below established levels, RBI can restrict costly liabilities, skip dividend payments, avoid some businesses, increase fee income. - If CRAR falls below 9 percent, RBI will require capital augmentation plan, restrict expansion of Risk-weighted Assets and require dividends reduced or skipped. - If CRAR falls to 6 percent, RBI will order recapitalization and may change directors or Management; failure to submit/implement recapitalization plan may lead to merger steps. - If CRAR falls below 3 percent, RBI will take steps to merge/amalgamate/liquidate or impose moratorium if CRAR does not improve beyond 3 percent within one year or such extended period as may be established. - Note: discretion can allow a bank to operate for potentially in excess of a year with extremely low capital; a 3 percent total capital level could involve very little common equity. - EC 6: Sections 46 and 47 give RBI power to apply penalties and sanctions to banking company, management, and Board members. - Assessment: Largely Compliant - Comments: - RBI has broad discretion and a set of tools for problem bank resolution and a prompt corrective action regime. - Some gaps exist, particularly related to applicability of approaches to public banks. *Source: _cr13267 - Section 71 of the PMLA has an overriding effect in case of inconsistencies with other law* ### 1. The RBI cannot disempower a public bank to withdraw from banking activities ### 1. The RBI cannot disempower a public bank to withdraw from banking activities ### Key observation on RBI powers over public banks - Even within the capital piece of the PCA regime, there is considerable discretion to allow a bank to continue to operate for potentially in excess of a year, with extremely low capital. - Given the CRAR is a total capital concept, a 3 percent total capital level could involve very little (common) equity. - If such discretion were exercised regarding a public bank, the government would presumably take action at some point. - The RBI can appoint the CEO or additional directors for a problem bank; as these persons are not granted additional powers, they may give the appearance of the RBI becoming involved in the management of a problem bank. - The RBI should provide greater clarity to these roles. ### Principle 24 — Consolidated supervision (description and assessment) - Principle: Supervisors should supervise the banking group on a consolidated basis, adequately monitoring and, as appropriate, applying prudential norms to all aspects of the business conducted by the group worldwide. - EC 1: Through required reporting and the AFI process, the RBI does maintain a good understanding of the overall structure and operations of banking groups, domestic and cross-border. - EC 2: Under Section 35 of the BR Act the RBI has the power to inspect a banking company, including its foreign operations (although it has not used such authority to inspect foreign operations since a May 2008 inspection of a bank’s subsidiary in the United Kingdom). - The RBI does not have the authority to inspect a subsidiary of a banking company that it does not regulate; such subsidiaries are generally subject to the supervision and regulation of separate Agencies, such as SEBI and IRDA. - The RBI has the authority to inspect the operations of foreign banks operating in India, under the same provisions applicable to domestic banks. - EC 3: Improvements in capacity to evaluate risks posed by nonbanking companies to supervised banking companies have been made, although improvement opportunities remain. - Two banking companies have more than 40 percent of their total activities in subsidiaries and associated companies. - A program of increased reporting and surveillance of Financial Conglomerates has been initiated; 12 financial conglomerates have been designated, with six of the twelve being bank-led conglomerates; the RBI is the designated lead supervisor of those six. - On a quarterly basis, the six companies file a special Conglomerate Return that provides consolidated financial information (including consolidated capital and exposure concentration information), capsule financial information on the individual nonbanking subsidiaries, information on the nature and dimension of intra-group transactions, and updates on elements of governance (including the composition of the Boards of directors). - Within the Department of Banking Supervision, a unit has been established with individuals designated for ongoing review of the six firms; the individuals are expected to share information and perspective with one another, and to interact with counterparts at SEBI and IRDA. - There is no provision for the sharing of inspection results directly between the nonbanking supervisory authorities and the RBI, even regarding subsidiaries of bank-led Financial Conglomerates, although copies of the relevant reports could be obtained by the RBI from the parent bank incident to the AFI process. - The Financial Conglomerate process contemplates semi-annual meetings of senior RBI people with counterparts from the relevant nonbanking supervisory authorities; the extent to which these meetings have been held on that schedule, and conducted in a way that would involve detailed discussion of concerns, has not been established with the assessors; meetings are carried out with representatives of the supervised institution, potentially limiting candor. - EC 4: The RBI has established prudential norms on a consolidated basis regarding capital adequacy, exposure norms, liquidity ratios, mismatches of assets and liabilities, and exposures to related parties. - The RBI collects consolidated financial information on banking companies, including balance sheet and profit and loss statement, supplementing more extensive reporting required on a solo-bank basis. - Non-financial and insurance subsidiaries (as well as associates and joint ventures) are excluded from the consolidated reports and norms. - The CAMELS construct is used for supervisory ratings; there is no explicit way to reflect issues arising from nonbank subsidiaries in the composite rating, in a separate component rating, or within any of the existing component ratings. - EC 5: There are no MOUs or other formal information sharing arrangements with SEBI and IRDA; any reports received by the RBI from those agencies are provided by the parent bank during the RFI. - A semi-annual meeting exists with an opportunity for information exchange in a more informal way, although meetings typically include senior officials of a supervised institution, potentially limiting candid communication. - An Integrated System of Alerts was established in 2003, under which regulated entities under SEBI (e.g., stock exchanges) send alerts to the RBI; no similar arrangements were advised regarding SEBI directly or regarding IRDA. - EC 6: The RBI has the authority to control the activities of a banking company and its subsidiaries through an applications process and through the banking law, which limits the activities of a subsidiary of a bank to what a bank can legally engage in directly. Locations are also controlled through the applications process, which includes review of annual branch banking plans with a focus on ensuring appropriate serving of under-banked areas. - EC 7: Based on a review of a sample inspection report, the RBI does an extensive view of the activities of overseas offices of the specific Indian bank as part of the AFI, including some assessment of managerial strength at such locations. - Capacity to determine in a rigorous way that foreign operations are managed in a safe and sound manner is limited by shortcomings in home/host information sharing arrangements and by the RBI’s very few on-site inspections of overseas operations — one in 2008, and none since that time. - EC 8: The RBI expects parent banks to review overseas operations on an ongoing basis, carrying out appropriate inspections and audits; banks are required to report to the RBI on overseas violations. - EC 9: Implicit authority exists for the RBI to require closing a foreign office or subsidiary if it is posing excessive risk to the parent bank. - EC 10: The RBI factors in the degree of supervisory intensity in a host jurisdiction when considering an application, but there is no well laid-out set of indicators to assess supervisory intensity consistently across jurisdictions. - In SREP (Pillar 2) reviews of banks with overseas offices/subsidiaries, the extent of risk at foreign offices is reviewed and supervisory discretion is used to counsel the bank if the trend of risk is increasing. - Assessment: Largely Compliant - Assessment comments: The RBI has taken steps to broaden supervisory focus to include consolidated group oversight, but gaps remain. ### Consolidated supervision: identified gaps and recommended improvements (from assessment comments) - Gaps: 1. The RBI cannot order inspections of, or require reports from, domestic non-subsidiaries it does not regulate; a proposed amendment (new Section 29 (A) of the BR Act, Power in Respect of Associated Enterprises) would, if enacted, address this deficiency. 2. The RBI does not receive inspection reports directly from nonbank supervisory agencies, reducing timeliness and regularity compared to obtaining such reports from the parent bank at the time of the AFI. 3. Opportunities to improve inter-Agency meetings: - by ensuring they take place on a fully regular schedule (for both designated Conglomerates and other banking companies with substantial nonbanking operations); and - by providing for the opportunity for candid conversation that would arise from portions of the meetings being regulators-only. 4. The RBI should consider its methodology for rating banking companies to provide explicitly a way to reflect systematically issues arising at nonbanking subsidiaries. 5. Major gaps exist in home/host information sharing arrangements as detailed in CP 25; the RBI has not used its powers to conduct overseas inspections since 2008. ### Principle 25 — Home-host relationships (description and assessment) - Principle: Cross-border consolidated supervision requires cooperation and information exchange between home supervisors and the various other supervisors involved, primarily host banking supervisors. Banking supervisors must require the local operations of foreign banks to be conducted to the same standards as those required of domestic institutions. - EC 1: Information exchanged between home and host supervisors is less than expected, particularly given the dimension of activities conducted by Indian banks overseas and the number of foreign banks operating in India. - Indian banks have operations in more than 45 countries, through branches, subsidiaries or joint ventures. - Thirty-seven foreign banks have branches in India. - EC 2: Formal information exchange arrangements are very limited. MOUs have been signed with only two authorities (China Bank Regulatory Commission in 2010 and Dubai Financial Services Authority in 2011). Discussions are in various stages with about 20 other jurisdictions. - Where MOUs are not in place, some information is exchanged from time to time as needed and/or based on reciprocal understandings with some supervisors. - Since the beginning of 2010, the RBI has received copies of some reports from UKFSA, the Federal Reserve, HKMA, and MAS. - The RBI has not hosted any supervisory colleges; it does participate in colleges organized by home country supervisors when invited, involving four banks over the past four years. - EC 3: The RBI as home supervisor provides limited information to host supervisors; it has never hosted a supervisory college. - EC 4: As host supervisor, the RBI provides limited information to home supervisors; it encourages home supervisors to meet with the RBI incident to any on-site reviews of branches in India. - EC 5: The RBI supervises offices of foreign banks in the same way as it supervises operations of local banks; the license granted to the foreign bank allows for the same array of activities as an Indian bank can conduct. - EC 6: The RBI ensures the home country supervisor is aware of a proposed establishment of an office and requests a letter of non-objection; however, there is no assessment of whether a home country practices consolidated supervision, although some limited review of supervisory intensity is made. - EC 7: Home country supervisors have been given access to the Indian offices of their banks to do on-site evaluations. - EC 8: No shell banks are permitted in India. - EC 9: While taking consequential action on the basis of information received from another supervisor has apparently not occurred, the RBI indicates it would consult with the other supervisor if the situation should arise. - AC 1: Communication strategies are not strongly formed, given limited formal and informal channels with overseas supervisors; the RBI has not hosted supervisory colleges although it has participated in colleges for four institutions over the past three years. - Assessment: Materially noncompliant - Assessment comments: The significant and growing overseas operations of Indian banks and the extent of foreign bank presence in India necessitate that the RBI significantly strengthen channels of communication and coordination with overseas supervisors. ### Home-host relationships: identified gaps and recommended improvements (from assessment comments) - Key gaps and concerns: 1. Indian banks have overseas operations in more than 45 jurisdictions, but the RBI has MOUs with only two; informal information sharing arrangements exist to varying degrees with only a few others, creating material gaps in information flow. 2. The RBI has not filled information gaps through overseas inspections; it has not done any overseas inspections since May 2008. 3. The RBI has not reached out to host jurisdictions by hosting supervisory colleges. 4. Some host jurisdictions where Indian banks operate include countries in unstable regions and/or where strong local supervisory practices may not be assured; reaching out to host supervisors for increased supervisory dialogue is appropriate. 5. The RBI does not clearly assess during the licensing process whether the home countries of foreign banks seeking to open offices practice consolidated supervision, nor does it carry out analysis of the quality of host country supervision through a rigorous, consistent, analytical process. - Organizational recommendation: - With the RBI now represented on the G-20, the FSB, and the Basel Committee on Banking Supervision, capacity to influence global policy would be enhanced with structural changes within the RBI to prepare representatives through better coordination and focus between various Departments. *IMF staff assessment as presented in the source* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr13267.pdf_