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

Cross-border supervision in the Indian system

Cross-border Banking

International efforts at streamlining the supervision of cross-border establishments have followed some banking crisis or the other originating in one country and having repercussions in a large number of other countries. It was following the failure of Bankhaus Herstatt in 1974 that the importance of collaboration between banking supervisors of different countries and concerted action to deal with banking institutions with cross-border presence was first recognised. It was natural that the initiative came from the BIS whose member countries, which broadly coincided with those of the G10 and the OECD, were the most affected by the crisis following the failure of Bankhaus Herstatt. These efforts resulted in the Basel Concordat of 1975 issued by the BCBS.

In the wake of further instances of bank failures, a revised Basel Concordat was issued by the BIS in May 1983 which replaced the earlier Concordat. The principles set out in this report, as stated therein, "are recommended guidelines of best practices in this area, which all members have undertaken to work towards implementing, according to the means available to them". In April 1990, certain practical aspects of these principles were elaborated in a Supplement to the Concordat.

In the wake of the failure of the Bank for Credit and Commerce International (BCCI) in 1991, it was felt that greater efforts needed to be made to ensure that the principles contained in the Concordat and the supplement can be applied in practice. Accordingly, some of these principles were reformulated as minimum standards which G-10 supervisory authorities expect each other to observe. In July 1992, the BCBS brought out the "Minimum Standards for the Supervision of International Banking Groups and their Cross-border Establishments".

In view of a number of problems experienced in the implementation of the above report, a working group set up by the BCBS and the Offshore Group of Banking Supervisors gave a set of detailed recommendations offering practical solutions. The twenty-nine recommendations of this group are set out in the document The Supervision of Cross-border Banking brought out by the BCBS in October 1996. As stated in the document, these recommendations "are aimed at improving and facilitating prudential supervision of banking risks with a view to ensuring the soundness of individual credit institutions and the stability of the financial system as a whole".

The relevant documents published by the BCBS and having relevance for supervision of cross-border establishments are as follows:

1. Principles for the Supervision of Banks' Foreign Establishments (The Basel Concordat) (May 1983)

2. Information Flows Between Banking Supervisory Authorities (April 1990)

3. Minimum Standards for the Supervision of International Banking Groups and Their Cross-Border Establishments (July 1992)

4. The Supervision of Cross-border Banking (October 1996)

Some of the principles contained in the papers at (a) and (b) above were reformulated and included in the paper at (c). Though the principles laid out in the above documents were for compliance by the G10 member countries, these have found a broad endorsement from a large number of non-G10 countries also. Progress in implementing the norms are being monitored in the biennial International Conference of Banking Supervisors.

The Group's major observations relating to deviations or gaps in the Indian system vis-à-vis international standards in respect of cross-border supervision are given below under the following heads:

1. Issues relating to nature of supervision

2. Issues relating to information sharing

3. Suggested changes in approach and methods of supervision

While supervising the branches of foreign banks operating in India, RBI looks mainly at the solvency of the branch. However, the solvency of the parent bank needs to receive a more pointed attention of a host country even if responsibility to monitor it is only general. Further, in the case of Indian subsidiaries of foreign banks engaged in activities not coming within the purview of Reserve Bank of India, the liquidity position of such subsidiaries is not monitored by RBI. It would thus appear that for supervision of subsidiaries of foreign banks which have branches in India as also for subsidiaries of Indian banks abroad, RBI would need to develop a more proactive and focused policy. With the growing complexities of an internationally integrated financial market this aspect of supervision merits much more attention than it has received so far.

The principle of consolidated supervision being unexceptionable, Reserve Bank of India needs to move in that direction. The accounting standards as well as the regulatory provisions need to be reviewed from this angle. A major obstacle in this regard which is faced by us is multiplicity of regulators on mutually exclusive basis. A suitable mechanism to coordinate their approaches shall have to be developed. RBI is, at present, not exercising its supervision on a consolidated basis although it has begun moving in that direction. Even at this stage, it needs to pay more attention to the operations of the subsidiaries of the entities it supervises whether or not their accounts are consolidated with that of the parent entity. RBI should also begin encouraging Indian banks and foreign entities operating in India to submit to consolidated supervision.

Although Reserve Bank of India's current supervisory stance aims at exercising comprehensive and consolidated supervision of the global activities of the Indian banks, in this regard it faces constraints in countries where the local laws do not permit the home supervisor to conduct onsite inspection/examination of records. There is no such legal or other hindrance to the parent supervisors from other countries conducting such inspections of the Indian branches of banks under their supervisory jurisdiction. Since reciprocity in these matters is important, country-wise analysis will have to be undertaken and suitable action taken where RBI faces constraints in its efforts to exercise consolidated supervision of the global activities of Indian banks.

The Group is of the view that RBI should have greater interaction with the home supervisors of foreign banks operating in India. It is presently not insisting on separate approvals of the home country supervisors of a foreign bank for every new branch which that bank wants to open in India. Such approvals are also not insisted upon from the home country supervisor of the banking group (where the bank is part of a banking group and the banking group's home country is different from the home country of the bank). RBI may consider the desirability of following the recommended approach as it will provide it with an opportunity to share with the home supervisors their latest views on the foreign entity under its supervisory charges in India.

Commonality of approach between the home and the host supervisors of supervised entities enables both the supervisors to exercise better supervision and helps them manage risks more comprehensively. Also, adequate information about the methods and standard of supervision of the counterpart supervisor helps the other concerned supervisor in calibrating and adjusting its own supervisory methodologies and standards in relation to the common supervised entity. It is, therefore, recommended that RBI may consider reviewing as a matter of regular practice the supervisory systems and standards of host supervision in countries where Indian banks have a presence.

RBI could supplement its own supervisory mechanism by using external auditors to look specially into certain selected areas and report to it independently. This it can do both in its capacity as the home and the host supervisor.

Host supervisors often remain inadequately informed about the parent bank's difficulties. It is, therefore, necessary that a more comprehensive system of information sharing based on mutuality and reciprocity be established.

RBI has so far not been seeking much information from the parent authorities of banks operating in India. In certain areas of their operations, particularly relating to the internal controls exercised by the concerned head offices of foreign banks operating in India, more information in regard to the quality of control exercised by their head offices is desirable. RBI may clearly convey to the home country supervisor its expectations about receiving from the home supervisor, information about the extent and quality of control maintained by the head office over its branches operating in India.

RBI does not receive at present from any of the parent supervisors, advices about the levels of materiality which would trigger their concern. Similarly, RBI is also not informing other host supervisors about such levels of materiality, the breaching of which in respect of its Indian bank branches abroad, may trigger its own supervisory concerns. The parent supervisors need to define and share with the host regulators levels of materiality in respect of major financial parameters, the failure to meet with which or the occurrence of certain significant adverse events should be reported by the host supervisors to them. In order to make this practice effective, the two supervisors would need to come to some kind of mutual agreement so that their perceptions about the triggers identified are common and the manner in which their respective concerns, following the appearance of triggers, are to be expressed do not vary too much.

Greater mutual understanding on the issue of prior consultations, in the likely event of supervisory action against specific banks, would need to be developed amongst the home and host country supervisors. RBI should insist on such information sharing as one of the conditions on which it permits a foreign bank to open its branch in India.

Without full reciprocity between supervisors on the issue of sharing information, its flow may become very uneven making cross-border supervision difficult. Unhindered and unqualified exchange of information between the home and the host supervisor may be prescribed by RBI as a precondition for permitting a bank to open offices abroad.

There is a case for incorporating strict legal provisions with regard to ensuring confidentiality of supervisory information so that such information is not shared with any agency, including central or state level vigilance/investigative agencies, but only when specifically called for by a court of law. As a related BIS document states, it needs to be emphasised, even in the event of a court demanding supervisory information, that making such information public may result in the drying up of such information and thus adversely affect the quality of supervision in the long run. The present legal provisions in India in respect of confidentiality of information available with the home supervisor (RBI) do not seem to be providing sufficient protection of information. More clearly defined laws would be needed for this purpose.

The suggested changes and areas where action needs to be initiated are highlighted below. An estimated timeframe within which such action could be completed is indicated.