Regulatory and Legal Environment

The advent of liberalization and globalization has seen a lot of changes in the focus of Reserve Bank of India as a regulator of the banking industry. De-regulation of interest rates and moving away from issuing operational prescriptions have been important changes. The focus has clearly shifted from micro monitoring to macro management. Supervisory role is also shifting more towards off-site surveillance rather than on-site inspections. The focus of inspection is also shifting from transaction-based exercise to risk-based supervision. In a totally de-regulated and globalised banking scenario, a strong regulatory framework would be needed. The role of regulator would be critical for:

1. ensuring soundness of the system by fixing benchmark standards for capital adequacy and prudential norms for key performance parameters.

2. adoption of best practices especially in areas like risk-management, provisioning, disclosures, credit delivery, etc.

3. adoption of good corporate governance practices.

4. creation of an institutional framework to protect the interest of depositors.

5. regulating the entry and exit of banks including cross-border institutions.

Further, the expected integration of various intermediaries in the financial system would add a new dimension to the role of regulators. Also as the co-operative banks are expected to come under the direct regulatory control of RBI as against the dual control system in vogue, regulation and supervision of these institutions will get a new direction. Some of these issues are addressed in the recent amendment Bill to the Banking Regulation Act introduced in the Parliament.

The integration of various financial services would need a number of legislative changes to be brought about for the system to remain contemporary and competitive. The need for changes in the legislative framework has been felt in several areas and steps have been taken in respect of many of these issues, such as,-

1. abolition of SICA / BIFR setup and formation of a National Company Law Tribunal to take up industrial re-construction.

2. enabling legislation for sharing of credit information about borrowers among lending institutions.

Integration of the financial system would change the way we look at banking functions. The present definition of banking under Banking Regulation Act would require changes, if banking institutions and non-banking entities are to merge into a unified financial system

While the recent enactments like amendments to Debt Recovery Tribunal (DRT) procedures and passage of Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act) have helped to improve the climate for recovery of bank dues, their impact is yet to be felt at the ground level. It would be necessary to give further teeth to the legislations, to ensure that recovery of dues by creditors is possible within a reasonable time. The procedure for winding up of companies and sale of assets will also have to be streamlined.

In the recent past, Corporate Debt Restructuring has evolved as an effective voluntary mechanism. This has helped the banking system to take timely corrective actions when borrowing corporates face difficulties. With the borrowers gaining confidence in the mechanism, it is expected that CDR setup would gain more prominence making NPA management somewhat easier. It is expected that the issue of giving statutory backing for CDR system will be debated in times to come.

In the emerging banking and financial environment there would be an increased need for self-regulation. This is all the more relevant in the context of the stated policy of RBI to move away from micro-management issues. Development of best practices in various areas of banks' working would evolve through self-regulation rather than based on regulatory prescriptions.

Role of Indian Banks' Association would become more pronounced as a self regulatory body. Development of benchmarks on risk management, corporate governance, disclosures, accounting practices, valuation of assets, customer charter, Lenders' Liability, etc. would be areas where IBA would be required to play a more proactive role. The Association would also be required to act as a lobbyist for getting necessary legislative enactments and changes in regulatory guidelines.

HR practices and training needs of the banking personnel would assume greater importance in the coming days. Here again, common benchmarks could be evolved. Talking about shared services, creation of common database and conducting research on contemporary issues to assess anticipated changes in the business profile and market conditions would be areas where organizations like Indian Banks' Association are expected to play a greater role.

Evolution of Corporate Governance being adopted by banks, particularly those who have gone public, will have to meet global standards over a period of time. In future, Corporate Governance will guide the way Banks are to be run. Good Corporate Governance is not a straight jacketed formula or process; there are many ways of achieving it as international comparisons demonstrate, provided the following three basic principles are followed:-

1. Management should be free to drive the enterprise forward with the minimum interference and maximum motivation.

2. Management should be accountable for the effective and efficient use of this freedom. There are two levels of accountability - of management to the Board and of the Board to the Shareholders. The main task is to ensure the continued competence of management, for without adequate and effective drive, any business is doomed to decline. As stated by J.Wolfensohn, President, World Bank - "Corporate governance is about promoting corporate fairness, transparency and accountability".

3. In order to enlist the confidence of the global investors and international market players, the banks will have to adopt the best global practices of financial accounting and reporting. This would essentially involve adoption of judgmental factors in the classification of assets, based on Banks' estimation of the future cash flows and existing environmental factors, besides strengthening the capital base accordingly.

When we talk about adoption of International accounting practices and reporting formats it is relevant to look at where we stand and the way ahead. Accounting practices being followed in India are as per Accounting Standards set by the Institute of Chartered Accountants of India (ICAI). Companies are required to follow disclosure norms set under the Companies Act and SEBI guidelines relating to listed entities. Both in respect of Accounting Practices and disclosures, banks in India are guided by the Reserve bank of India guidelines issued from time to time. Now these are, by and large, in line with the Accounting Standards of ICAI and other regulatory bodies. It is pertinent to note that Accounting Standards of ICAI are based on International Accounting Standards (IAS) being followed in a large number of countries. Considering that US forms 40% of the financial markets in the world compliance with USGAAP has assumed greater importance in recent times. Many Indian banks desirous of raising resources in the US market have adopted accounting practices under USGAAP and we expect more and more Indian Financial entities to move in this direction in the coming years.

There are certain areas of differences in the approach under the two main international accounting standards being followed globally. Of late, there have been moves for convergence of accounting standards under IAS and USGAAP and this requires the standard setters to agree on a single, high-quality answer. Discussions in the accounting circles indicate that convergence of various international accounting standards into a single global standard would take place by 2007.

In the Indian context, one issue which is likely to be discussed in the coming years is the need for a common accounting standard for financial entities. While a separate standard is available for financial entities under IAS, ICAI has not so far come out with an Indian version in view of the fact that banks, etc. are governed by RBI guidelines. It is understood that ICAI is seized of the matter. It is expected that banks would migrate to global accounting standards smoothly in the light of these developments, although it would mean greater disclosure and tighter norms.