Module: 2
Financial Standards and Codes: Report of Advisory Group on Banking Supervision

Foreword & Introduction

Standing Committee on International Financial Standards set up The Advisory Group on Banking Supervision with Shri M. S. Verma, Chairman, Telecom Regulatory Authority of India as the chairman and S/Shri Janki Ballabh, Chairman, State Bank of India, K. R. Ramamoorthy, Chairman, Vysya Bank and H. N. Sinor, Managing Director, ICICI Bank as members.

The broad framework for the working of the Group included

1. Study of the present status of applicability and relevance as well as compliance in India of the relevant standards and codes;

2. Study of the feasibility of compliance and the timeframe within which this can be achieved, given the prevailing legal and institutional practices in India

3. Comparing the levels of adherence in India vis-�-vis industrialised countries and also emerging economies particularly to understand India�s position and to prioritise action on some of the more important codes and standards; and

4. Chalking out a course of action for achieving the best practices.

The first part of the Report was submitted in September 2000. The Report covered areas relating to corporate governance, bank transparency, supervision of cross-border banking and banks� internal rating systems. In the second part of its report, submitted on May 29, 2001, the Group has assessed the level of compliance in India vis-�-vis the principles/ standards detailed in the 16 papers on the subject of banking regulation and supervision brought out by the Basel Committee on Banking Supervision of the Bank for International Settlements. The second part was submitted on June 06, 2001. For the purpose of providing an integrated view, the core contents of the first report has been merged with the second Report.

Though the name of the Group only refers to "Banking Supervision", the Group has defined its scope to include both banking regulation and supervision. This The approach is in line with the approach adopted by the Basel Committee on Banking Supervision (BCBS) of the Bank for International Settlements (BIS) in setting "Core Principles for Effective Banking Supervision" which cover both regulatory and supervisory aspects. With a view to ensuring uniformity of standards and providing a level playing field within a country, that these are best applied across the banking sect, the Group, at the outset itself, decided that the scope of its assessment of the Indian position in respect of regulation and supervision shall extend to the whole of the commercial banking sector as it is understood in India. This comprises the State Bank Group, nationalised banks, private sector banks and foreign banks operating in the country.

While making its assessment in regard to the Indian position, the Group has concluded that given the level of complexity and development of Indian banking sector, the level of compliance with the standards and codes is of a high order. It has, however, pointed out a number of areas in which improvements are called for. In the areas of corporate governance, internal control and management of risks, the Group has looked hard at the present practices and found certain urgent changes to be necessary. The most important recommendation in respect of corporate governance relates to the constitution of the boards and their accountability. In regard to the risk management, the Group has concluded that the current situation calls for greater orientation of the banks� management and their boards towards a better understanding of the risks and their management. In the opinion of the Group, the banks are handicapped in implementing a reliable credit rating and other risk management systems due to (a) lack of qualified personnel, (b) absence of reliable high frequency historical data, and (c) lack of proper appreciation of risks management concepts at the middle and senior management levels. Similarly, in regard to loan accounting and credit risk management, the Group has recommended that the formulae based system of classification and provisioning should give way to a more closer to reality assessment of the realisability of assets, relying on a risk-assessment based system.

The Group�s assessment has been categorised under the following headings:

1. Core Principles for Effective Banking Supervision

2. Corporate Governance

3. Internal Control

4. Management of Credit Risk

5. Loan Accounting, transparency and disclosures

6. Financial Conglomerates

7. Cross-border Banking

Along with the detailed assessment on the subjects as indicated above, the Advisory Group has appened to its Report, its "Conclusions" in Chapter 9 of the Report and "Summary of major recommendations" under Chapter -10.

As per the Group's statement the different facets of banking regulation and supervision, as listed above, have been ordered in what is felt to be a logical sequence of importance in ensuring banking soundness. Thus, the Core Principles refer to the minimum requirements to be met as essential conditions for ensuring sound banking supervision. Good Corporate Governance is essential to a bank�s soundness and no level of high achievement in other areas can be a substitute for it. Similarly, effective Internal Control is of almost equal importance since this is the first layer of discipline over any bank�s functioning. Managing Credit Risk is one of the oldest functions of a bank and banks� ability in ensuring profitability of its operations on a sustained basis hinges upon its success in this area. Market discipline is essential to ensure sound functioning of banks. Similarly, the health of banks is often a barometer of a country�s financial soundness and ability to meet its liabilities. In this context, adhering to internationally accepted practices in respect of Loan accounting, transparency and disclosure play an important role in disciplining banks and in avoiding unwarranted speculation. Adherence to basic principles in respect of supervising Financial Conglomerates is necessary in this era of deregulation and overlapping of market activities to ensure that there are no gaps in supervision. Finally, increased Cross-border banking has given rise to the need to ensure that poorly supervised activities in one jurisdiction do not jeopardise the soundness of systems elsewhere.

The Advisory Group on Banking Supervision has recommended that the Reserve Bank of India may urgently consider the desirability of introducing and participating in a scheme of formalised coordination between different regulators. It has also recommended designation of one of the regulators involved as a primary regulator and coordinator with clearly assigned roles and responsibilities.