Constitution

The Committee on Financial System set up by the Government of India had suggested that the supervisory functions of RBI should be separated from the more traditional central banking functions and that a separate agency, which could pay undivided attention to supervision, should be set up under the aegis of RBI. A complete severance of supervision from central banking was not considered necessary or desirable in the Indian context. So, based on this recommendation, the first Board for Financial Supervision (BFS) was constituted on November 16, 1994 by the Governor as a committee of the Central Board of Directors of the Reserve Bank of India (RBI). It functions under the RBI (BFS) Regulations, 1994 exclusively framed for the purpose in consultation with the Government of India. The Board is chaired by the Governor and is constituted by co-opting four non-official Directors from the Central Board as Members for a term of two years. The Deputy Governors of the Bank are ex-officio Members. One of the Deputy Governors is nominated as Vice-Chairman. The Department of Banking Supervision serves as the Secretariat for the BFS.

The Board has since been reconstituted for a term of two years in consultation with the Central Board in its meeting held on 21 December 2000, Department of Banking Supervision and Department of Non-Banking Supervision participate in the BFS meetings by invitation. In-charges of these departments are also to be in attendance for the meetings.

The Chairman, Vice-Chairman and Members of the Board jointly and severally exercise the powers of the Board. The Board is at present required to meet ordinarily at least once a month. Three Members, of whom one shall be Chairman or the Vice-Chairman, form the quorum for the meeting.

For tendering advice to the BFS in its initial years on policy matters relating to the supervision of the financial system an Advisory Council was constituted on November 16, 1994 and was in place till March 27, 1998. The Council consisting of five members, eminent in the fields of law, accountancy, banking, finance and management met normally once a quarter during the period of its tenure.

The BFS also constituted an Audit Sub-Committee in January 1995 with the Vice Chairman of BFS as Chairman of the sub-Committee and two non-official members of BFS as other Members. Representatives of the Institute of Chartered Accountants are also invited to the meetings of the Sub Committee depending on the nature of the agenda. The Sub Committee's main focus is on up-gradation of the quality of the statutory audit and concurrent audit / internal audit functions in banks, NBFCs and financial institutions, fixing of remuneration, approval of the panel of statutory auditors and branch auditors as also the accounting and disclosure standards.

The supervision by BFS at present covers commercial banks, all India development financial institutions and non-banking finance companies.

In its very first meeting, the BFS approved a new strategy of supervision, the key elements of which include:

1. Setting up an off-site surveillance function, the major components of which include establishing a system for in-house monitoring of banks and other credit institutions, based on a prudential supervisory reporting framework; building a "Memory" on all supervised institutions and setting up a market intelligence and surveillance unit (MISU)

2. Restructuring the system of bank inspections in terms of focus, process, reporting & follow up.

3. Strengthening the statutory audit of banks and enlarging the role of auditors in the supervisory process including using them as agents.

4. Strengthening the internal defences within the supervised institutions such as corporate governance, internal control and audit functions, and management information and risk control systems, as an extension of the task of supervision.

To start with, expert working groups were constituted in 1994 to devise revised strategies of on-site supervision over banks and NBFCs for continuous supervision. Some of the important steps taken based on the recommendations of these working groups are as under:

• Changes in frequency/periodicity of inspections, restructure reporting formats and introduce new off-site reporting system, introduction of three types of supplementary on-site assessments in between the statutory examinations, Rating system for banks based on the international CAMELS model as also more focused and enforcement-oriented follow-up based on the recommendations of Padmanabhan Working Group.

• Toning up of the internal control/audit function in banks and more particularly the safeguards to be adopted in EDP environment.

• Introduction of an effective prudential reporting system and registration process for NBFCs by switching over from the then prevailing compliance monitoring system with reference to RBI directions on deposit taking activities of such companies.

• The reports of a few more Working Groups/ Committees are either under consideration or the reports are expected shortly.

A Working Group consisting of senior officials of banks and RBI reviewed the reporting/monitoring system covering overseas operations of Indian banks and recommended a series of measures for toning up the head office/RBI supervision in this area. The revised procedures, which were finalised in consultation with the banks, have come into force from the quarter ending June 2000.

A Working Group of professional bankers constituted in July 1998 examined the practices followed by public sector banks in arriving at compromise settlements and recommended certain guidelines that may be followed by banks. These guidelines have been circulated amongst banks for adoption.

A Working Group comprising internal auditors from banks and Chartered Accountant professionals constituted in July 1998 recommended guidelines for RBI Inspectors for objective evaluation of the internal audit system in banks. Based on these guidelines, a checklist has been designed for the use of the bank inspectors and also circulated amongst banks for use by their internal auditors.

In the context of growing incidence of large value frauds in banks a Working Group of experienced bankers was set up in June 1998 to conduct an in-depth study of frauds of Rs.1 crore and above reported by commercial banks during the last three years. The Group, after analysis of over 100 large value reported frauds, made several recommendations for improving the fraud prevention /monitoring system in banks. The report has been forwarded to the banks with advice to initiate immediate action

Considering delay in adjustment of outstanding entries in nostro accounts of public sector banks a Working Group consisting of senior level officers from public sector banks and RBI was set up in March 1998 to suggest solutions. After analysing the important causes for large pending entries and the present system and procedure followed by banks in the area of reconciliation of nostro accounts entries, the Group suggested various measures for effective control and management of nostro accounts reconciliation which have been communicated to banks.

Considering the large proportion of investments in unquoted bond/ debentures made by banks through private placements under non- SLR category, a Technical Group, with officials drawn from Treasury Departments of banks, was set up in August 1998 to study and suggest appropriate measures. The Group was assigned the task of suggesting measures for regulating such investment and bringing in more transparency, accountability and risk perception. The recommendations of the Group were examined in consultation with experts on the subject and suitable prudential guidelines for valuation of SLR/Non SLR investments were issued to come into effect from September 30, 2000.