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Chapter 16 Financial Sector Supervision

Chapter 16 Financial Sector Supervision. Supervision Function- A Retrospective. Banking Regulation Act 1949 Inspection under Section 35 Inspection for certain specific purposes under sections 22(3), 37(2), 38(4), 44(1), 44A, 44B, 45Q. Prudential Reporting System was set up in 1985

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Chapter 16 Financial Sector Supervision

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  1. Chapter 16Financial Sector Supervision

  2. Supervision Function- A Retrospective • Banking Regulation Act 1949 • Inspection under Section 35 • Inspection for certain specific purposes under sections 22(3), 37(2), 38(4), 44(1), 44A, 44B, 45Q. • Prudential Reporting System was set up in 1985 • Health code Reporting was introduced in 1986 • Department of Supervision (DoS) was set up in 1995 for off-site monitoring of banks.

  3. Supervision of Banking Companies • Inspection by Reserve Bank of India • On-site Surveillance • Off-site Surveillance • Statutory Audit • Internal Audit

  4. Reviews of The System of Inspections • Pendharkar Committee (1985) • Padmanabhan Committee (1991) • Jilani Committee (1995)

  5. Pendharkar Working Group • Financial inspections- • Visit to Head Offices, Controlling Offices and cross section of branches for making a detailed assessment of the bank’s operation • Periodicity- Two years for private and foreign banks and Four years for public sector banks. • Annual financial reviews- • For Public Sector Banks other than SBI • Visits to Head Office and a quarter of the controlling offices • Relied mostly on the MIS in banks

  6. Padmanabhan Group • Replacement of annual financial Review by • Annual Financial Inspections • Biennial Management Audits • Utilisation of the services of audit professionals for scrutiny of certain specified areas of banking operations. • Reducing of time span of inspection to 4 to 5 months • Delegation to Regional Offices of DoS

  7. Jilani Group • Administrative set-up of Inspection and Audit Departments in banks • Staffing of Inspection and Audit Department • Scope and coverage of Inspection/Audit • System and criteria regarding rating of branches • Concurrent Audit

  8. Jilani Group • Follow-up and compliance of inspection reports • Inspection and control of subsidiaries of banks • Computer Audit • Frauds in Banks • Emerging areas of concern in banking business

  9. Administrative Set-up(Decentralized System) AGM (Inspection/ Audit) HO Chief Internal Auditors Senior Internal Auditors Internal Auditors Stock Inspecting Officer

  10. Typical Organizational Chart GM (Inspection)/CVO DGM (Inspection AGM AGM Chief Chief Chief • Reporting & Monitoring (ELB/VLB) • Admin. Office Inspection • Programming cell • Computer Audit • system committee • Audit Committee • Policy Matters • Establishment • Frauds & Investigation • Complaints • Reporting & Monitoring • Customer Service Cell

  11. Internal Audits • Regular Inspection at Periodical Intervals • Surprise Inspections • Concurrent Audit • Inspection for specific purposes • Management Audits • Foreign Exchange Inspection • Deal Room Audit

  12. Financial Regulation & Supervision • International Financial Architecture • Foreign Direct Investments in the Banking Sector • Money Laundering and Financing of Terrorism

  13. Core Principles of Effective Banking Supervision Principle 24 Corrective and Remedial Powers of Supervisors Principle 22 Accounting and Disclosure Principles 24-25 Consolidated & Cross-border Banking Supervision Principles 19-21 Methods of ongoing Banking Supervision Core Principles of Effective Banking Supervision Principle 1 Objectives, Independence, Powers, Transparency and Cooperation Principles 6-18 Prudential Regulation & Requirements Principles 2-5 Licencing and Structure

  14. Core Principles of Effective Banking Supervision • Principle 1: Objectives, independence, powers, transparency and cooperation • Principle 2: Permissible activities • Principle 3: Licensing criteria • Principle 4 : Transfer of significant ownership • Principle 5: Major acquisitions • Principle 6 : Capital adequacy • Principle 7: Risk management process • Principle 8: Credit risk • Principle 9: Problem assets, provisions and reserves • Principle 10: Large exposure limits • Principle 11: Exposures to related parties • Principle 12: Country and transfer risks

  15. Core Principles of Effective Banking Supervision • Principle 13: Market risks • Principle 14: Liquidity risk • Principle 15: Operational risk • Principle 16: Interest rate risk in the banking book • Principle 17: Internal control and audit • Principle 18: Abuse of financial services • Principle 19: Supervisory approach • Principle 20: Supervisory techniques • Principle 21: Supervisory reporting • Principle 22: Accounting and disclosure • Principle 23: Corrective and remedial powers of supervisors • Principle 24: Consolidated supervision • Principle 25: Home-host relationships

  16. Basel Accord • Basel Committee was established in 1974 by the Governors of Central Banks of Group of Ten countries • Established as the Committee on Banking Regulations and supervisory Practices • The serious disturbances in international currency and banking markets consequent to the failure of the Bankhaus Herstatt in West Germany

  17. Basel Accord • Members are Belgium, Canada, France, Germany, Italy, Japan, Luxembourg, Netherlands, Sweden, Switzerland, United Kingdom and United States • The Committee issued its first document on banking supervision in 1975 • 1983 the Committee finalized a document "Principles for the Supervision of Banks’ Foreign Establishments" which set down the principles for sharing supervisory responsibility for banks’ foreign branches, subsidiaries and joint ventures between host and parent (or home)

  18. Basel Accord • The 1983 document revised the earlier paper published in 1975 and is known as ‘Concordat’ • In April 1990, a Supplement to the 1983 Concordat was issued with the intention of improving the flow of prudential information between banking supervisors in different countries • In June 1992 certain of the principles of the Concordat were reformulated as Minimum Standards.

  19. Basel Accord • In July 1992 the Standards were published. • In October 1996, the Committee released a report drawn up by a joint working group • presented proposals for overcoming the impediments experienced by banking supervisors in conducting effective consolidated supervision of the cross-border operations of international banks • This report was endorsed by supervisors from one hundred and forty countries who attended the International Conference of Banking Supervisors (ICBS) in June 1996

  20. Basel Accord • In October 1998 a survey was conducted to monitor the progress made in overcoming obstacles to effective consolidated supervision. • Following comments on a consultative paper published in December 1987, a capital measurement system commonly referred to as the Basel Capital Accord (or the 1988 Accord) was approved by the G-10 Governors and released to banks in July 1988 • In November 1991, it was amended to give greater precision to the definition of those general provisions or general loan-loss reserves which could be included in capital for purposes of calculating capital adequacy

  21. Basel Accord • In September 1993, a statement was issued confirming that all the banks in the G-10 countries with material international banking business were meeting the minimum requirements laid down in the 1988 Accord • In April 1995, the Committee issued an amendment to the Capital Accord, to take effect end-1995, to recognize the effects of bilateral netting of banks’ credit exposures in derivative products and to expand the matrix of add-on factors

  22. Basel Accord • In April 1996, a further document was issued explaining how Committee members intended to recognize the effects of multilateral netting. • In January 1996, the Committee issued an additional amendment to the Capital Accord, effective end-1997, designed to incorporate within the Accord the market risks arising from banks' open positions in foreign exchange, traded debt securities, equities, commodities and options

  23. Basel Accord • In June 1999, the Committee issued a proposal for a new capital adequacy framework to replace the 1988 Accord • The proposed capital framework consists of three pillars: • minimum capital requirements, • supervisory review of an institution's capital adequacy and internal assessment process; and • effective use of market discipline as a lever to strengthen disclosure and encourage safe and sound banking practices

  24. Basel Accord In addition to work on the Concordat and capital standards, particular supervisory questions include the supervision of banks’ foreign exchange positions, the management of banks’ international lending (i.e. country risk), the management of banks’ off-balance-sheet exposures, the prevention of the criminal use of the banking system, the supervision of large exposures and risk management guidelines for derivatives

  25. Basel Accord • In February 2000, the Committee issued Sound Practices for Managing Liquidity in Banking Operations. • The other guidelines includes, those relating to electronic banking, derivatives, corporate governance in banks, transparency etc. • India also has accepted the Basel Accord and the RBI has prescribed norms for capital adequacy in tune with the international standards.

  26. Regulatory Authorities • Securities and Exchange Board of India • Stock Exchanges • Reserve Bank of India • Ministry of Finance, Government of India • Bank for International Settlements - Basle Accord

  27. Securities and Exchange Board of India • Established under The Securities and Exchange Board of India Act 1992 • Replaced The Securities Contracts Regulations Act 1956 • Controls and Regulates The Capital Market Operations In The Country

  28. Guidelines • Disclosure and investor protection • Raising foreign equity in existing companies and determining issue price of preferential shares • Determining issue price for raising foreign equity in existing companies through preferential allotment of shares to non-residents

  29. Guidelines • Merchant banking activities • Issue of securities by development financial institutions • Issue of NOC for release of deposit kept with the regional stock exchanges • Issue of foreign currency convertible bonds and ordinary shares (through depository mechanism)

  30. Guidelines • External Commercial Borrowings • Euro Issues • Securities Lending Scheme • Good/Bad Deliveries • Foreign Institutional Investors • Mutual Funds • Employees’ Stock Option Scheme

  31. Rules and Regulations • Trading mechanism and business rules for OTCEI • Stock brokers and Sub-brokers • Insider trading • Merchant bankers • Portfolio managers • Appeal to Central Government

  32. Rules and Regulations • Registrars To An Issue And Share Transfer Agents • Underwriters • Debenture Trustees • Annual Report of SEBI • Form of Annual Statements and Records of SEBI • Bankers to an Issue

  33. Rules and Regulations • Holding inquiry and imposing penalties by adjudicating officer • Prohibition of fraudulent and unfair trade practices relating to securities market • Foreign Institutional Investors • Custodian of securities • Depositories and participants

  34. Rules and Regulations • Venture capital funds • Mutual funds • Substantial acquisition of shares and takeovers • Buy back of securities • Credit rating agencies • Collective investment scheme • Foreign venture capital investors

  35. Stock Exchange Rules • Listing • Filing of reports • Reporting of book closures • Reporting of board meeting • Reporting of AGM • Trading system

  36. RBI Guidelines • Banking operations • Non-banking financial companies • External commercial borrowings • Leasing and hire purchase by banks • Preferential allotment of shares to non-residents

  37. GOI Guidelines • Issued by Ministry of Finance • Banking companies • Non-banking companies • External commercial borrowings • Foreign investments in India • Companies Act

  38. Companies Act Guidelines • Public issue of shares • Right issue of shares • Bonus issue of shares • Employees’ stock option scheme • Book building • Allotment of shares • Buy back of shares

  39. Companies Act Guidelines • Sweat equity • Transfer of shares • Prospectus • Deemed prospectus • Statement in lieu of prospectus • Public deposits • Investments- inter-company loans

  40. Companies Act Guidelines • Inter-corporate deposits • Borrowings • Debentures • Bonds

  41. RBI Guidelines • Issue of shares to NRIs and OCBs • Remittance of dividends abroad • Portfolio management • Housing finance • Bill discounting • Factoring and forfeiting

  42. IRDA Guidelines • Disclosure requirements for insurance companies • Agents’/ intermediaries’ responsibility of implementation of Anti-money Laundering Programme • Filing of ALM policy with IRDA • Compliance of KYC Norms • Prohibition from entering into contract with customers whose identity matches with known criminals, terrorists etc. • Classification of customers based on risk profile • Screening of agents/ employees/ corporate agents at the time of hiring • Training on AML to agents/ intermediaries

  43. IRDA Guidelines • Remittance of premium above Rs.50000 through banking channels • Submission of Transaction Report/ Cash Transaction Report to FIU-IND • Maintenance of record of transaction by insurer/agents/ corporate agents • Internal auditors of insurance companies to verify compliance with policies, procedures and controls relating to money laundering activities • KYC norms for General Insurance Companies

  44. On-site & Off-site Surveillance by IRDA • Off-site Surveillance • Periodical returns and reports such as • Financial reports • Reports covering investment functions, actuarial and survey aspects, reinsurance etc. • On-site • Targeted inspections • Investment audits • IRDA is in the process of introduction of a comprehensive supervisory process covering • Credit risk • Market risk (covering interest rate risk and foreign exchange risk ) • Insurance risk (including product design and pricing risk, underwriting and liability risk) • Operational risk • Liability risk, • Legal and regulatory risk, • Strategic risk and • Reputation risk

  45. Risk Management Function • Operational management • Financial analysis and reporting to management • Compliance functions • Regulatory policies and procedures • Board’s policies and procedures • Senior management’s policies and procedures • Internal audit • Risk management process • Identification of risks, • Development of measurement systems for risks, • Establishment of polices and procedures to manage risks, • Development of risk tolerance limits, • Monitoring of positions against approved tolerance limits, • Reporting the results of risk monitoring to senior management and the Board • Senior management and systems in place

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