The regulatory and supervisory frameworks for banks and other institutions in India have undergone significant changes, keeping pace with the reforms introduced in the financial sector.

some of the more important regulatory measures are highlighted as under:

The focus of the statutory regulation of commercial banks in India until the early 1990s was mainly on licensing, administration of minimum capital requirements, pricing of services including administration of interest rates on deposits as well as credit, reserves and liquid asset requirements. In these circumstances, the supervision had to focus essentially on solvency issues.

After the evolution of the BIS prudential norms in 1988, the RBI took a series of measures to realign its supervisory and regulatory standards almost on a par with international best practices. At the same time, it also took care to keep in view the socio-economic conditions of the country, the business practices, payment systems prevalent in the country and the predominantly agrarian nature of the economy, and ensured that the prudential norms were applied over the period and across different segments of the financial sector in a phased manner. The Indian banking system is at present subjected to the following prudential norms:

• Exposure to a single borrower should not exceed 25% of the bank's capital funds (i.e. paid up capital and free reserves).

• Group exposure should not exceed 50% of the capital funds of the bank. An additional 10% is allowed in respect of exposure to infrastructure projects (power, telecom, roads & ports).

• Section 20 of the Banking Regulation Act prohibits loans to directors or to any firm or company in which directors hold an interest.

• The banks should maintain an arms-length relationship in respect of own subsidiaries or joint ventures; all loans to such companies have to be made at commercial rates and are subject to limits which apply to similar companies.

• There is an aggregate ceiling fixed for loans related to owned funds of the subsidiary.

Under the risk-weighted asset approach for the purpose of capital adequacy standards, the minimum CRAR has been prescribed at 8% and will be further raised, to 9% (which is already applicable to banks permitted to trade in gold), with effect from 31 March 2000.

Under the Income Recognition Norms, income from non-performing assets cannot be taken as part of the profits of banks unless the income has been realised.

The definition of 'past due' for a period of any two quarters in a financial year in respect of interest or installment of principal under a credit facility has been adopted as part of the Asset Classification

• Based on the status of an asset as an NPA, it is required to be classified as standard, substandard, doubtful and loss assets and appropriate provisions made.

• Banks are required to make a general provision of 10% of the total outstanding under substandard assets.

• A doubtful asset has been defined as one which has remained as an NPA for a period exceeding 2 years and provisions are required at 100% of the unsecured portion and 20 to 50% in respect of the secured portion over a period of 3 years. The period for reckoning an NPA as doubtful will be further shortened, to 18 months, by 31 March 2001.

• Banks are required to write off the entire loss assets or make 100% provision therefor.

• Banks are required to create provisions on government guaranteed NPAs from 1 April 2000.

• A general provision of 0.25% on standard assets has to be made for the year ending 31 March 2000.

Banks are required to bifurcate their investments in approved securities (govt. or govt. guaranteed securities and bonds) into "permanent" and "current" investments. The ratio of permanent investment to total investment has been reduced from a high of 70% in 1992-93 to 30% in 1998-99 and the intention to mark 100% of bank's investments to market (as current investments) over the next 3 years has already been announced. While appreciation in the value of securities is ignored, depreciation has to be fully provided for.

The aforesaid prudential standards compare favourably with some of the international best practices already in vogue in developed economies.

The entire supervisory mechanism has been realigned since 1994 under the directions of a newly constituted Board for Financial Supervision (BFS), which functions under the aegis of the RBI, to suit the demanding needs of a strong and stable financial system. The supervisory jurisdiction of the BFS now extends to the entire financial system barring the capital market institutions and the insurance sector.

The periodical on-site inspections, and also the targeted appraisals by the Reserve Bank, are now supplemented by off-site surveillance which particularly focuses on the risk profile of the supervised institution. A process of rating of banks on the basis of CAMELS in respect of Indian banks and CACS (Capital, Asset Quality, Compliance and Systems & Control) in respect of foreign banks has been put in place from this year.

The Off-site Monitoring and Surveillance System (OSMOS) was introduced in 1995 as an additional tool for supervision of commercial banks to supplement the on-site examinations. The system consists of 12 returns (called DSB returns) focussing on supervisory concerns such as capital adequacy, asset quality, large credits and concentrations, connected lending, earnings and risk exposures (viz. currency, liquidity and interest rate risks). As part of the first tranche, 7 returns have so far been operationalised and the second tranche of returns on risk management aspects and consolidated supervision is expected to be introduced by next year.

The supervisory intervention by the RBI is normally triggered by the deterioration in the level of capital adequacy, NPAs, credit concentration, lower earnings, and larger incidence of frauds which reflect the quality of control.

Like the central banks in developed supervisory regimes, the RBI also has started placing an increasing reliance on professional accountants in the assessment of internal control systems of the banks and non-bank financial institutions. Over the period, the responsibilities of auditors have been delineated not only to make the audit more detailed but also to make them accountable. The methodology and processes used to generate available data as certified by the audit profession would improve the reliability of financial statements as regards their conformity with national accounting and disclosure standards.

Another area of crucial importance is the strengthening of internal control systems in banks. The Reserve Bank has, over the years, emphasised the need for having an effective internal control system in banks. Banks have also been advised to introduce the system of concurrent audit in major and specialized branches. As a result, all commercial banks have introduced concurrent audit since 1993 by using external auditors as a major resource. The banks are now required to set up audit committees to follow up on the reports of the statutory auditors and inspection by the RBI. Similarly, immediate action is warranted on reconciliation of inter branch accounts which, if left unreconciled, are fraught with grave risks. Substantial progress has been made by banks in reconciliation of the outstanding entries, and the BFS reviews progress in this area at quarterly intervals.

It is now commonly acknowledged that the Indian banking sector has, as a result of the ongoing reforms, emerged strong and resilient. The public sector banks which suffered losses of Rs.3,293 crore in 1992-93 and Rs.4,349 crore in 1993-94, i.e. in the initial years of introduction of prudential norms, have ended the year 1997-98 with a net profit of Rs.5027 crore. Net NPAs of public sector banks formed 8.2% of the net advances and 3.3% of the total assets as at the end of March 1998.

Financial institutions carry a wide range of risks, including credit, interest rate, foreign exchange, liquidity, operational and reputational risks. These risks are highly interdependent and events (whether expected or unanticipated) that affect one area of risk can have ramifications on other risk categories. In the context of deregulation of interest rates in India, market risk has now emerged as an area requiring immediate attention on the asset side of the balance sheet. In recognition of this, the RBI has issued to the banks draft guidelines (with the final guidelines becoming operational from 1 April 1999) for a broad framework for asset-liability management, taking into account the variance in the business profile of banks in the public sector and private sector as well as the data/information base available to banks in India.

Another area where the RBI has moved ahead is to impart greater transparency to the balance sheets of banks. This was a logical step after the adoption of prudential norms, with the banks in India coming under greater international scrutiny. During the last couple of years, the range and extent of disclosures has been gradually increasing so as to provide a clearer picture to informed readers of balance sheets. The banks are now required to disclose the break-up of the provisions made towards NPAs, depreciation of investments and other purposes besides, the capital adequacy ratio and the level of net non-performing assets.

With effect from 1997-98, banks are required to disclose accounting ratios relating to income heads like operating profit, return on assets, business per employee and profit per employee.

From the year ending 31 March 2000, the following information, among others, should also be disclosed by the banks operating in India in the published accounts:

• Maturity pattern of loans and advances, investment securities, deposits & borrowings,

• Foreign currency assets and liabilities,

• Movements in NPAs & provisions,

• Lending to sensitive sectors as defined by the RBI from time to time.

The primary objective of any supervisory regime has to be prudential, viz., to protect the safety and soundness of domestic banking systems. Its application can at the same time provide an incentive for other countries to improve the quality of their prudential supervision. If banks want to operate in other markets where these core principles are strictly applied, they will have to convince the authorities in the host countries that the quality of supervision in their home country is adequate. This can create powerful new incentives for improvements in supervision.