Internationally, following the failure of some large banks and bank related entities, there has been a debate on the segregation of supervision from traditional central banking, citing the conflict between monetary policy objectives and bank supervision objectives. At the same time, there is also a considered view that bank supervision function can provide the central bank with far more information from and control over the institutions and markets and thus assist in maintaining financial stability. The financial markets have become more sophisticated and global in nature, adding to the challenges faced by central banks while at the same time rapid strides in telecommunication and electronic data processing coupled with new funding instruments, growth of securitisation, emergence of new institutions have increased the role and responsibilities of bank supervisors

The legal and institutional framework for bank supervision in India is provided under the Banking Regulation Act, 1949. Until 1994, different departments in Reserve Bank of India were exercising supervision over banks, non-banking financial companies and financial institutions. To keep a close watch on financial markets and avoid recurrence of crisis in the financial system, the Board for Financial Supervision was set up under the aegis Reserve Bank under Reserve Bank of India (Board for Financial Supervision) Regulations, 1994 with the objective of paying undivided attention to the supervision of the institutions in the financial sector.

Prior to 1993, the supervision and regulation of commercial banks was handled by the Department of Banking Operations & Development (DBOD). In December 1993 the Department of Supervision was carved out of the DBOD with the objective of segregating the supervisory role from the regulatory functions of RBI.

Globally, increasing financial dis-intermediation has led to an increase in the assets and reach of non-bank finance companies necessitating enhanced regulatory attention towards these non-bank and near-bank entities. The merger of Financial Institutions Cell with the Department of Supervision in June 1997 led to the formation of an exclusive Financial Institutions Division within the DoS which was entrusted with both supervision and regulation over all India development financial institutions. Later, the Department of Supervision was split into Department of Banking Supervision (DBS) and Department of Non-Banking Supervision (DNBS) on July 29, 1997 with the latter being entrusted with the task of focussed regulatory and supervisory attention towards the NBFC segment.

The Department of Banking Supervision at present exercises the supervisory role relating to commercial banks in the following forms:

1. Preparing of independent inspection programmes for different institutions.

2. Undertaking scheduled and special on-site inspections, off-site surveillance, ensuring follow-up and compliance.

3. Determining the criteria for the appointment of statutory auditors and special auditors and assessing audit performance and disclosure standards.

4. Dealing with financial sector frauds.>

5. Exercising supervisory intervention in the implementation of regulations which includes - recommendation for removal of managerial and other persons, suspension of business, amalgamation, merger/winding up, issuance of directives and imposition of penalties.

Department of Non-Banking Supervision has following responsibilities:

1. Administration of Chapter IIIB of the RBI Act, formulating regulatory framework and issuing directions to the NBFCs (including residuary non-banking companies, mutual benefit companies, chit fund companies);

2. Administration of Chapter III-C of the RBI Act in respect of unincorporated bodies, Chit Funds Act in respect of chit fund companies, Prize Chits and Moneys Circulation Schemes (Banning) Act in respect of prize chits;

3. Identification and classification of NBFCs;

4. Registration of NBFCs under section 45-IA of the RBI Act;>

5. On-site inspection and follow up;

6. Off-site surveillance and scrutiny of various returns;

7. Attending to complaints relating to NBFC sector; and

8. Initiating deterrent action against the errant companies.

Considering the manifold growth of NBFCs , a new regulatory framework was put in place in January 1998 to ensure that only financially sound and well run NBFCs are allowed to access public deposits. After interaction with the industry representatives and considering the recommendations of the Task Force on NBFCs set up by the Government, these regulations were modified in December 1998. The regulations and guidelines governing NBFCs are also made available periodically on the RBI websites as part of public domain information.

The experience of supervision in the intervening period has, however, led to the recognition of the fact that existing legislative framework requires further refinement because of the rising number of defaulting NBFCs and the absence of a quick redressal system for individual depositors. Government of India appointed a Task Force to go into the adequacy of the legislation, which has made wide ranging recommendations. Based on these, a draft 'Financial Companies Regulation' Bill has been prepared which will address the lacunae in procedures and statute.

The major instrument of supervision of the financial sector is inspection. The inspection process focuses mainly on aspects crucial to the bank's financial soundness with a recent shift in focus towards risk management. Areas relating to internal control, credit management, overseas branch operations, profitability, compliance with prudential regulations, developmental aspects, proper valuation of asset/ liability portfolio investment portfolio, and the bank's role in social lending are covered in the course of the inspection. The Department undertakes statutory inspections of banks on the basis of an annual programme, which is co-terminus with the financial year for public sector banks. After the inspection report is released to the bank, followed by a 'supervisory letter' based on the inspection findings to the bank, the concerns of the inspections are discussed with the CEO of the bank and a Monitorable Action Plan is given to the bank for rectification of those deficiencies. The Department submits a memorandum covering supervisory concerns brought out by the inspection to the Board for Financial Supervision (BFS). Specific corrective directions of the BFS are conveyed to the banks concerned for immediate compliance. The Memoranda submitted by the departments for supervisory scrutiny and consideration of BFS generally cover matters relating to supervisory strategy and operational supervision of individual banks, financial institutions and non-banking financial companies as also industry-wide issues and sectoral performance reviews

Closer supervision on the asset quality and fixing responsibility on the board and accountability on top management of banks has had a perceptible impact on the Non Performing Assets (NPAs) of public sector banks. The banks have shown a declining trend in terms of percentage of NPAs to total advances during the last four years. The percentage of gross NPAs to gross advances of public sector banks declined from a high level of 19.45 at the end of March 1995 to 13.86 as on 31 March 2000. The net NPAs formed 8.07% of the net advances as on 31st March 2000.

The Capital to Risk-weighted Assets Ratio (CRAR) for banks initially fixed at 8% was increased to 9% from March 2000. The position of banks not achieving the prescribed CRAR level since 1995 has come down from 42 banks (14 public sector) as on 31 March 1995 to 4 banks (1 public sector) as on 31 March 2000 due to constant monitoring and directions for improvement in this area at quarterly intervals.