A. Information and Methodology Used for Assessment

10. This assessment was against the standard issued by the Basel Committee on Banking Supervision (BCBS) in 2012. Since the past BCP assessment, which was conducted in 2011, the BCP standard has been revised. The revised Core Principles (CPs) strengthen the requirements for supervisors, the approaches to supervision, and the supervisors’ expectations of banks through a greater focus on effective risk-based supervision and the need for early intervention and timely supervisory actions. Furthermore, the 2012 revision placed increased emphasis on corporate governance and supervisors’ conducting sufficient reviews to determine compliance with regulatory requirements and thoroughly understanding the risk profile of banks and the banking system. This assessment was thus performed according to a significantly revised content and methodological basis, compared to the previous BCP assessment carried out in 2011 (Box 1).

11. Both essential and additional criteria (AC) have been assessed, but only essential criteria (EC) have been graded by the assessors. To assess compliance, the BCP Methodology uses a set of EC and AC for each principle. The EC were usually the only elements by which to gauge full compliance with a CP. The AC are recommended as the best practices against which the authorities of some more complex financial systems may agree to be assessed and graded.

12. Grading is not an exact science and the CPs could be met in different ways. The assessment of compliance with each principle is made on a qualitative basis. Compliance with some criteria may be more critical for effectiveness of supervision, depending on the situation and circumstances in a given jurisdiction. Emphasis should be placed on the commentary that should accompany each Principle grading, rather than on the grading itself.

13. The assessment team held extensive meetings with RBI officials, as well as the MoF, the industry, and other relevant counterparts who shared their views with the assessors. The team also reviewed the framework of laws, regulations, and supervisory guidelines. The RBI provided self-assessments of the CPs and comprehensive questionnaires filled out by the authorities. The RBI also facilitated access to supervisory documents and files, staff, and systems.

14. The assessment team appreciated the excellent cooperation, including extensive provision of internal guidelines, supervisory files, and reports. In particular, the team would like to thank the RBI staff who responded to the extensive and detailed request promptly and accurately during the assessment at a time when supervisory staff were burdened by many supervisory and regulatory initiatives related to resolving stressed bank assets.

A. Sound and Sustainable Macroeconomic Policies

19. The Indian economy has recorded strong growth in the recent past, supported by robust macroeconomic policies. The implementation of wide-ranging policies to correct imbalances and build buffers after the Taper Tantrum woes of mid-2013, together with robust capital inflows and low commodity prices, reduced India’s external vulnerabilities, with current account deficits averaging 1.4 percent of GDP over the past three years. The RBI has adopted a flexible inflation targeting regime (August 2016), with a formal inflation target band, and introduced a statutory Monetary Policy Committee (September 2016). The stance of monetary policy has been consistent with achieving the interim inflation targets.

20. Fiscal and structural reforms are also expected to improve economic fundamentals and increase predictability of the business environment. Fiscal policies envisage a gradual return to consolidation. The implementation of the pan-India Goods and Services Tax is expected to help create a single national market and enhance the efficiency of intra-Indian movement of goods and services. The authorities are also systematically tackling supply-side bottlenecks and promoting broader structural reforms. The recent major currency exchange initiative is expected to bring more economic activities into the formal sector and to spur digitalization of financial transactions, although it has strained consumption and business activity in the short term.

21. Several policy initiatives to address the build-up of risks in the banking system have been taken:

• Asset quality review: In 2015 an extensive RBI-led Asset Quality Review (AQR) took place, covering the loan portfolios of the 36 largest banks, comprising 93 percent of the total loans in the banking system. In light of the AQR’s findings, many banks were advised to clean up their books by recognizing the impairments and completing the provisioning by March 2017. The AQR revealed significant quantities of NPAs, and the authorities are considering how to address this issue and provide additional capital to banks that have become undercapitalized.

• Corporate debt restructuring schemes: The RBI introduced three new schemes in 2015 to facilitate debt-equity swaps and other forms of loan restructuring—5:25 Refinance Scheme; Strategic Debt Restructuring (SDR); and Scheme for Sustainable Structuring of Stressed Assets (S4A).

• Insolvency regime: The 2016 Insolvency and Bankruptcy Code unifies bankruptcy treatment of corporates and individuals under a single law and aims to reduce debt resolution to 180 days from 4.3 years currently. The 2016 Bill on Enforcement of Security Interest and Recovery of Debts aims to support faster bank asset recovery.

• Banking sector revitalization. The government’s Indradhanush Plan, announced in 2015, was intended to revitalize the PSB sector by injecting capital and improving PSBs’ governance, autonomy from government, risk controls, and capacity to deal with stressed assets. Greater consolidation of the 27 PSBs is also being considered as a way to address weak PSBs.

• Development of corporate funding alternatives. The RBI liberalized regulations on external commercial borrowings (ECBs) by corporates in 2015, including fewer end-use restrictions and higher debt ceilings, and in 2016, it allowed infrastructure companies and certain NBFCs to tap the ECBs. Also, a new framework introduced in 2015 sanctions the issuance of rupee-denominated (Masala) bonds overseas. More broadly, the 2016 RBI Measures for Development of Fixed Income and Currency Markets proposes a plan to develop India’s corporate bond and currency derivatives market.

B. Framework for Financial Stability Policy Formulation

22. The Financial Stability and Development Council (FSDC) in India is the apex-level body tasked with maintaining financial stability. The FSDC was established in 2010 as a non-statutory body in charge of ensuring inter-agency coordination for financial stability, along with financial sector development and inclusion mandates. The FSDC is chaired by the finance minister, and its members include the heads of all the financial sector regulators (RBI, SEBI, PFRDA, and IRDAI) and key representatives from the MOF. All decisions are reached through consensus, while their implementation lies with the relevant participating domestic authority. There is no explicit mechanism under the FSDC to consider potential trade-offs between its various mandates (see FSB Peer Review of India, 2016). The FSDC’s sub-committee (FSDC-SC) is the executive arm of the committee and is chaired by the RBI governor. Under the FSDC-SC, there are permanent technical groups to promote inter-agency cooperation (i.e., the Inter-Regulatory Technical Group discusses issues relating to financial stability risks; the Inter-Regulatory Forum coordinates cross-sectoral policies on financial conglomerates; the Early Warning Group (EWG) analyzes signals of stress in the financial system).

23. The RBI has taken important steps to develop the toolkit for macroprudential policy. Given the largely bank-based financial system, macroprudential analysis and policy are mainly carried out by the RBI. Since 2004, the RBI has voluntarily included financial stability as an additional institutional objective. The RBI has expanded the use of quantitative systemic risk-assessment tools and stress tests, while the main findings of its financial stability analyses are reviewed by the FSDC-SC and published in the Financial Stability Report (FSR). Progress has also been made in addressing data gaps, and steps are underway to form a Financial Data Management Center to facilitate overall information sharing and analysis (see FSB Peer Review of India, 2016).

C. A Well-Developed Public Infrastructure

24. The Corporate Insolvency and Bankruptcy Code (2016) created time-bound processes for insolvency resolution of companies and individuals. The code consolidated and amended the laws relating to reorganization and insolvency resolution of corporates, partnership firms, and individuals in a time-bound manner, and for maximization of value of the assets. The code requires that bankruptcy processes be completed within 180 days, or else the borrowers’ assets may be sold to repay creditors. The new regulator, the Insolvency and Bankruptcy Board of India, exercises regulatory oversight over insolvency professionals, insolvency professional agencies, and informational utilities.

25. Convergence with International Financial Reporting Standards (IFRS) is pending. Accounting standards are set by the Institute of Chartered Accountants of India (ICAI), but the RBI can require specific carve-outs or modifications for commercial banks. The IFRS has been transposed in the Indian Accounting Standards (Ind AS) and will be implemented by scheduled commercial banks and certain categories of NBFCs in April 2018. For banks, the RBI issued directions in February 2016 on the Ind AS roadmap. The new accounting standards will allow timelier recognition of credit losses and provide forward-looking information, but imply a steep learning curve for the accounting profession, banks, and supervisors, where further guidance and dissemination of good practices may be needed.

26. Indian auditing standards are broadly in line with international auditing standards. The ICAI is in charge of setting audit standards that are in close alignment with the corresponding International Standards on Auditing issued by the International Auditing and Assurance Standards Board. Bank’s annual financial statements are to be audited by an RBI-approved auditor, who must present a true and fair view of the bank’s financial position.

27. The payment, clearing, and settlement infrastructures are well developed. The Payment and Settlement Systems Act, 2007, was enacted for regulation and supervision of payment systems in India and designates the RBI as the authority to regulate the payment and settlement systems in India. The Act was further amended in 2015 to further strengthen the payment and settlement systems, and to bring it at par with international norms, so as to ensure stability and transparency in the financial system, and to enable financial sector entities to deal with international financial sector entities in the globally integrated financial world without any difficulty or disruption.

28. Banks are expected to have a detailed Code of Customer Rights and minimum standard of practices. The RBI is responsible for enforcing disclosure standards for banks. Banks have to disclose among other items: service charges, interest rates, services offered, product information, time norms for various banking transactions, and the grievance-redressal mechanism. The RBI’s Banking Ombudsman scheme acts as the quasi-judicial authority for resolving disputes between a bank and its customers. The RBI also set up a Customer Redressal Cell, a Customer Service Department in 2006, and the Banking Codes and Standards Board of India, which is an autonomous body for promoting adherence to self-imposed codes by banks for committed customer service.

D. Framework for Crisis Management, Recovery, and Resolution

29. The FSDC is expected to coordinate the authorities’ responses during a crisis. The EWG of the FSDC is tasked with the analysis of early warning signals and coordination of the responses from the government and the regulators in the occurrence of a crisis situation. The EWG is chaired by the DG of the RBI in charge of the Financial Markets Department, and includes representatives from the MOF and other financial sector regulators. At present, crisis management, contingency planning, and resolution reside primarily with the sectoral regulators; an overarching framework for crisis preparedness seems to be lacking.

30. The RBI has some resolution powers under the current framework. At present, the RBI has some powers to deal with the resolution of commercial banks in terms of mergers, imposition of moratorium, suspension of management, and liquidation. However, it is constrained in the exercise of corrective powers over PSBs, their government-appointed Board members, and senior management. Due to the dual control exercised by the RBI and the government—the latter being vested with powers related to governance, management, liquidation, etc.—the scope of the corrective powers employed by the RBI are limited also in the case of Urban Cooperative Banks.

31. The resolution framework is about to be substantially revamped. The government has taken steps to establish a full-fledged Resolution Corporation (RC) covering the entire financial sector and to introduce a comprehensive resolution framework in broad alignment with the FSB’s Key Attributes of Effective Resolution Regimes for Financial Institutions. A draft Bill on Financial Resolution and Deposit Insurance has been submitted to the parliament for consideration. The bill proposes, among others, measures to address some important gaps in the current resolution framework in terms of legal powers, resolution tools, timelines of triggering resolution, and cooperation among relevant authorities.

E. Public Safety Net

32. The RBI has a broad range of powers to meet the liquidity needs of the financial system. Under sections 17 and 18 of the RBI Act, the RBI has wide discretion to lend to economic agents on a system-wide or individual basis, and in normal and exceptional circumstances in support of its policy goals. While not explicitly provided for in the law, the RBI has interpreted its lender-of-last-resort arrangement as being a discretionary facility available to solvent banks that face temporary liquidity needs, provided in the interest of depositors, and to prevent the failure of the bank.

33. A deposit insurance system is in place. The Deposit Insurance and Credit Guarantee Corporation (DICGC) is a wholly owned subsidiary of the RBI. It insures all commercial banks, including branches of foreign banks functioning in India, local area banks, cooperative banks, and regional rural banks. Primary cooperative societies are not insured by the DICGC. It covers all deposits (savings, fixed, current, recurring, etc.) up to a maximum of Rs 1,00,000 per depositor. The DICGC is liable to pay to each depositor through the liquidator the insured amount within two months from the date of receipt of the claim list from the liquidator. The proposed RC would also subsume the role of the DICGC.

F. Effective Market Discipline

34. Key governance and disclosure requirements for market participants are spelled out in the Indian Companies Act of 2013. The Act contains provisions relating to Board constitution, Board meetings, Board processes, independent directors, general meetings, audit committees, related-party transactions, and disclosure requirements in financial statements, etc., in all financial institutions.

35. Additional disclosure requirements applicable to banks are set by the RBI or as part of mandatory disclosures for listed companies. For example, banks are required to make disclosures on asset quality, exposures to sensitive industry sectors, unsecured exposures, and key financial ratios, etc. The RBI Guidelines on remuneration and compensation are only applicable to private sector banks and foreign banks operating in India and not to PSBs. Finally, as listed companies, banks are also subject to a broad range of disclosures.

36. Improving the governance in PSBs remains work in progress. A corporate governance reform plan for PSBs was launched through publication of the Indradhanush plan in August 2015. The plan included separating the post of chairman and CEO/managing director of a PSB, and establishing a Banks Board Bureau (BBB) in place of the previous Appointments Board to take over the role of recommending to the government the appointment of PSB’s executive directors, CEO/managing director, and non-executive chairman. It also included a statement that, going forward, “there will be no interference from government and Banks are encouraged to take their decisions independently keeping the commercial interest of the organization in mind.” The authorities should keep following through on their commitment to enhance PSBs’ governance.

A. Responsibilities, Objectives, Powers, Independence, and Accountabilities (CPs 1–2)

37. The RBI’s supervisory responsibilities and powers are generally well established. There are no material gaps in coverage of the Indian system of bank supervision and regulation. This is evident from legislation, the public stance of the RBI, and the content of the RBI’s guidance. The legal framework gives the RBI powers to authorize banks to conduct ongoing supervision, address compliance with laws, and undertake timely corrective actions to address safety and soundness concerns. Laws and regulations are updated frequently.

38. There is a need to clarify the RBI’s formal objectives and to strengthen its independence. Supervisory objectives and the first priority of safety and soundness are not clear in the law, although it is evident that the RBI is committed at the operational level to ensuring the safety and soundness of the banking system. Supervisory powers over PSBs are incomplete, as the RBI has no legal ability to dismiss PSB Board members, merge PSBs, or revoke their statutory authority to conduct banking business.³ Furthermore, the government appoints the governor of the RBI for a maximum term rather than a minimum term, and can dismiss him or her without cause.

39. Legal changes are recommended to clarify supervisory objectives, provide full supervisory powers over PSBs, and to limit appeals or overrides of supervisory decisions. Formal grounding of the RBI’s independence in exercising its supervisory attributes would provide greater legal certainty. Legislation should be amended to enable the RBI to extend all the powers currently exercised over private sector banks to PSBs; in particular, regarding Board member dismissals, mergers, and license revocation. The RBI Act should be amended to appoint the governor for a minimum term, ending the government’s ability to dismiss the governor without cause. It should also remove the option of an appeal to the government when the RBI revokes a license. If statutory changes are difficult, the RBI and the government should consider adopting a framework agreement whereby the government would acknowledge the RBI’s full operational authority and independence in supervision and regulation, as they did recently for monetary policy.

B. Ownership, Licensing, and Structure (CPs 4–7)

40. Permissible activities for banks, licensing, transfers of ownership, and bank mergers and acquisitions are appropriately defined and controlled. The use of the word “bank” is controlled and deposit taking is confined largely to banks, although any deposit taking by institutions that are not regulated as banks should be prohibited. Guidance and processes for scrutiny of license applications are adequate in almost all respects. The RBI should require groups that own significant shares of a bank to list all their beneficial owners and to report promptly to the RBI any material changes in the holdings of those shares.

C. Ongoing Supervision (CPs 8–10, 12, and 15)

41. The RBI has made substantive changes in moving toward the implementation of a risk-based approach, but further enhancements are necessary. The SPARC framework was introduced in FY 2013. The framework deploys an adequate mix of onsite and offsite supervisory tools. The core of risk assessment under SPARC is a proprietary statistical model called IRISc, which is a multi-tiered scorecard with qualitative assessments. Appropriately, these assessments are updated dynamically in response to changes in strategy and circumstances, but the process of implementation and adjustment should be managed strictly to maintain consistency and the framework’s robustness. Assessors noted that the model needs independent review and validation.

42. The enforcement link between SPARC assessments and supervisory actions is weak with respect to imposing capital add-on. The assessors noted that a bank’s Risk Assessment Report (RAR) does not discuss the bank’s identified capital shortage in association with necessary capital augmentation or risk-mitigation plans. Although there were cases requiring identified capital add-ons, none was followed by supervisory actions; that is, by a written request for capital augmentation. The RBI should enhance the robustness of the RBS framework by clearly linking the SPARC assessments to enforceable supervisory actions.

43. Formal comprehensive guidelines regarding the oversight of compliance with RAR action points need to be established. The RBI states that non-compliance with action points within the agreed timeline is managed by the SSMs and gets factored into the assessment of governance and oversight function under SPARC. However, without formal guidelines on the oversight of compliance, it is difficult to ensure that the bank’s compliance of action points is managed and enforced in a consistent manner across all banks.⁴

44. It would be useful also to develop supervisory assessment handbooks to ensure consistency across banks and supervisory judgements. Once the RBI enhances the robustness of the SPARC framework, it should consider developing detailed SPARC assessment handbooks to improve the consistency of its supervisory framework.

45. The extent of the assessment of resolvability of banks is limited under the SPARC framework. Recovery and resolution plans have not been required by the RBI. The establishment of a recovery and resolution regime and the risk assessment pertaining to the resolvability of large banks (such as domestic systemically important banks (D-SIBs)) needs to be considered upon the passage of the resolution legislation bill.

46. Other improvements should be sought in the engagement with banks’ Boards, bottom-up stress tests, and consolidated supervisory returns. The supervisor should maintain frequent contact with the bank’s Board and non-executive Board members to better understand and assess matters such as strategy, group structure, corporate governance, performance, risk management systems, and internal controls. More active engagement with independent Board members is needed. The RBI should consider finalizing and utilizing the stress testing methodology to identify, assess, and mitigate emerging risks across banks as a complementary supervisory tool. The authorities should consider enhancing the collection of data for purposes of consolidated supervision in terms of frequency and granularity.

D. Corrective and Sanctioning Powers (CP 11)

47. In almost all respects, the RBI has sufficient supervisory powers, but—as discussed above—there are limitations, particularly with respect to PSBs. Legislation should be amended to remove any statutory limitations on the RBI’s ability to enforce regulations in PSBs, including in the areas of Board member removal, mergers, and withdrawals of licenses. Furthermore, any private sector license revocation could be appealed on its merits to government, whose decision is final. Legislation should be amended to give the RBI full authority to revoke a bank license without appeal to the GOI; and to ensure it can act independently with respect to PCA enforcement.

E. Cooperation and Cross-Border Banking Supervision (CPs 3, 13)

48. A framework has been put in place for cooperation and coordination of the RBI with other domestic financial regulators. In February 2013, a Memorandum of Understanding (MoU) was signed to facilitate cooperation in the supervision of the 11 financial conglomerates in India. The MoU envisages information sharing among regulators, subject to the legal requirements of professional secrecy, coordinated onsite inspections of entities within the conglomerates, and early information of each other in case of crisis. The MoU does not yet envisage joint inspections, but work is ongoing to develop a framework in this area. In the area of financial stability, the RBI’s mandate could be strengthened usefully. It is recommended to include more explicit provisions in the applicable bills, acts, and regulations to support recovery and resolution actions mutually. The FSDC-SC, Early Warning Group, and the FDSC working group committee structures could be streamlined to achieve clearer mandates and more efficient coordination.

49. Since 2010, the RBI has embarked on a successful program to conclude MoUs with foreign regulators. Agreements were concluded with 43 jurisdictions, covering information sharing, onsite examinations, crisis management, confidentiality, and meetings of the authorities, and supervisory colleges have been established for the six Indian banks with cross-border operations. The RBI chairs the meetings of the supervisory colleges for these banks, and the most important home and host authorities are invited. In the past five years, the RBI has established formal relationships with overseas supervisors, including colleges for its six largest internationally active banks. Thirty-six onsite inspections were performed in the establishments of 15 Indian banks abroad; a number of these jointly with the host authority. The RBI staff report good day-to-day working relationships with their main foreign counterparts.

F. Corporate Governance (CP 14)

50. The appropriate rules on fitness and propriety, and banks’ internal governance structures, are in place with respect to private and foreign banks. Nevertheless, the influence the RBI may exercise on banks’ governance through section 21 BR Act, placement of RBI representatives on banks’ Boards, and the RBI’s very limited authority under the Banking Acts, as well as the custom to hold the PSB Boards accountable has become problematic. Under the law and according to custom, the RBI cannot hold PSB Boards accountable for assessing and—when necessary—replacing weak and nonperforming senior management and government-appointed Board members. Moreover, the government’s and the RBI’s roles in appointing senior management and placing their own officials on the Boards creates a conflict of interest with regard to the exercise of supervision and the PSB’s business decisions.

51. Several improvements are necessary in the area of PSB governance. Consistent with the recommendations contained in the Indradhanush Plan and 2014 Nayak report, the Banks Board Bureau (BBB) should be able to appoint and remove senior management of PSBs, assuming the role presently carried out by the MOF. Over time the banking laws should be changed to empower the RBI and the Boards of PSBs to exercise the same responsibilities for PSBs as now apply to private banks. When the law is amended, the requirement that PSB Boards include, ex officio, the RBI, as well as the power of the RBI by virtue of section 21 BR Act may need to be amended.

G. Capital, Risks, Problem Assets, Provisions and Large Exposure (CPs 16–19, 22–25)

52. The RBI has adopted the Basel III capital adequacy framework. In a 2015 Regulatory Capital Assessment Program (RCAP), with which the assessors concur, under the aegis of the Basel Committee, the RBI framework was assessed to be compliant with the Basel Framework. The RBI capital framework also includes a capital conservation buffer, leverage ratio, and countercyclical capital buffer. These frameworks apply to public as well as private sector banks. At this time, the RBI offers only the standardized approach for credit, market, and operational risk. However, currently the RBI is reviewing applications of several banks to apply the Internal Ratings Based Approach (IRB) for credit risk. No authorizations have yet been granted, pending validation of banks’ models and the conduct of parallel runs.

53. The regulations and supervision on risk management are considered broadly adequate. The RBI comprehensively prescribes banks’ systems for credit risk management. Board approval is required for banks’ risk strategy. A sound organizational structure for risk management is required, including a Risk Management Committee, a Risk Management Department, and a robust loan review process. With regard to credit risk, for instance, banks are required to set up an internal risk rating system, incorporating financial analysis, projections and sensitivity, and industrial and management risks. Review of credit risk should take place twice per year by independent loan review officers. Banks report to the RBI quarterly on loan quality, classification, and provisions.

54. All banks need to follow guidelines and meet targets on priority sector lending, which compromises banks’ independent, risk-based credit allocation policies and strategies. These public policy-oriented constraints can impose significant limitations on the banks’ own development of credit risk management strategies and policies, and may lead to risk accumulation. The RBI should consider reviewing PSL policy, including targets and scope of application to allow banks flexibility in meeting PSL targets, if proposed projects do not meet banks’ commercially based risk management strategies and processes.

55. The introduction of IFRS 9 provides an opportunity to strengthen loan classification and provisioning rules. The RBI may need to maintain a prudential filter as a regulatory floor after the introduction of accounting expected loan-loss provisioning in April 2018. In this context, the RBI should review its existing classification and provisioning rules to ensure they are calibrated in line with actual losses and cure rates. If necessary, regulatory parameters should be adjusted for more timely recognition of appropriate provision. The RBI should also reassess the need for amending special loan categories that could weaken the loan classification and provisioning adequacy. Also, the RBI should develop a reporting tool and enhance monitoring, by closely assessing the materiality, trend, and build-up of risks in special situations in a systematic way. Furthermore, it is important to note that good practices are continuously evolving in the areas of prudential treatment of problem assets, nonperforming exposures and forbearance.⁵ The RBI should stay on top of this and align its practices and regulations as soon as possible with new regulatory developments. Finally, given the high level of NPAs in the system, the authorities should consider a more proactive approach to ensure that banks, via adequate provisioning, have proper incentives to tackle NPAs and free up balance sheets for more productive lending.

56. The RBI has introduced a revision of the large exposure and risk concentration rules that aim to fully converge with the Basel guidance. Although the new circular fully enters into force only in April 2019, it already prescribes significantly lower general limits on exposure to individual borrowers and groups of borrowers of 20 percent and 25 percent of bank Tier 1 capital, versus the current general limits of 25 percent and 40 percent, respectively. However, the current system still offers differentiated treatment for a significant number of special situations that need to be reviewed and simplified, with the objective of sound risk management rather than special treatment for socially sensitive or priority projects.

57. The RBI allows banks to include Indian State Government Securities, also known as State Development Loan (SDLs) in the level 1 HQLA buffer. In 2015, the Basel Committee (RCAP)⁶ reviewed the features of the SDLs and concluded that they do not qualify as sovereign debt securities in the context of the Basel standards. The inclusion of SDLs resulted in a material upward effect on reported liquidity, which hampers its international comparability. The RBI does not consider it necessary to rectify this rule, which is considered satisfactory from a prudential point of view. CP 24 stipulates that the liquidity requirements should not be lower than those prescribed in the applicable Basel standards. Therefore, the inclusion of the SDL in the level 1 HQLA is one of the shortcomings assessors have observed. The RBI should consider reviewing and enhancing regulation of liquidity risk management to be more in line with Basel standards.

58. The RBI should consider expanding the scope of supervisory reporting of operational risk events and associated losses. Aspects of operational risk reporting and examination are in place; a comprehensive guideline on Cyber Security Framework in banks was issued in June 2016; a Cyber-Security and Information Technology Examination Cell was launched; and reporting of financial fraud was well established. However, with regard to non-IT operational risk, the formal reporting protocol has limited applicability other than fraud. There may be scope to strengthen other aspects of operational risk reporting, such as reporting on human errors, processing errors, and external events.

H. Other Regulation, Accounting, and Disclosure (CPs 20, 26–29)

59. The RBI has issued the Guidelines on Intra-Group Transactions and Exposures, which include related-party transactions (RPTs) since the last FSAP. However, the rules over RPTs still have room for improvement. For instance, there is no explicit requirement for Board approval to be obtained prior to related-party (RP) exposure write-offs. It is unclear that the intragroup exposure limit is applied to RPTs between a bank and its major individual shareholder or family. In addition, other regulations affecting RPTs are scattered across several supervisory documents or legal texts making it difficult to define a clear framework of RPTs. It would be beneficial if the regulations/guidelines of RP add further clarification.

60. The internal control regulations issued by the RBI are adequate and are supported by the requirements of the SPARC risk-based supervision system. This system provides extensive guidelines for inspection of the internal control and audit function, and prescribes that a bank’s internal controls allow identification and controlling of risks. The Internal Audit Departments in banks are required to have appropriate resources and staff with the requisite skills. Tasks can be outsourced, allowing additional expertise to be brought in. The auditors reported that overall experience with the quality of internal audit of banks was satisfactory.

61. The ICAI, a statutory body, issues the Accounting Standards (AS) applicable to all listed companies, including banks.⁷ Banks are also governed by RBI norms on income recognition, asset classification and provisioning, and classification and valuation of investment portfolios. Banks are required to publish audited financial statements annually in the regional newspaper. Only external auditors approved by the RBI and who are on the list of approved auditors are permitted to audit banks. Starting April 1, 2018, Indian Accounting Standards (Ind-AS) will converge with IFRS, including IFRS 9 on expected losses. The RBI prescribes rotation of audit firms every 3–4 years. The accounting and auditing professions are of high quality, and bank accounting standards are comprehensive.

62. Currently, the external auditor is not obliged to report immediately to the RBI regulator any issues encountered in the audited bank that are of material interest to the supervisor. This is only permitted after publication of the annual statements. Moreover, regulators need powers to access the auditor’s working papers when needed. This is currently not envisaged. The laws and/or regulations should explicitly authorize the external auditor to inform the RBI of any concerns at any time; also, before the annual statements have been finalized and published. The RBI should be given the explicit authority to obtain information at any time from the external auditor.

63. With regard to the AML/CFT framework, there is currently no specific requirement imposed on banks with regard to the treatment of customers who are domestic politically exposed persons (PEPs). In line with FATF Recommendation 12, in addition to performing customer due diligence (CDD) measures required by the standard, the banks should be required to take reasonable measures to determine whether a customer or beneficial owner is a domestic PEP or a person entrusted with a prominent function by an international organization and, in cases where there is a higher risk business relationship with such a person, to take enhanced due diligence measures. In addition, the know your customer (KYC) rules do not highlight in the definitions section that banks are required to identify beneficial ownership where the customer is an individual. This constitutes a deficiency, given that money-laundering activities often involve the engagement of front men to obscure the identity of beneficial owners.

64. The AML/CFT reporting framework is not sufficiently broad to meet the CP. Although the controls over reporting financial fraud are well established, financial fraud is only one type of predicate crime among the AML/CFT concerns over money-generating criminal activities. The RBI should broaden its reporting requirements to address money-laundering issues, not just fraud.