abstract governance leadership

8/7/2019 Abstract Governance Leadership

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LEADERSHIP THROUGH GOVERNANCE: THE CASE OF THE RESERVE BANK OF

INDIA

T.V.Rao

Abstract:

Governance Leadership is critical in any sector of the economic structure and

more so in the financial sector. The Leadership displayed by the Reserve Bank

of India in securing a Resilient and robust Banking system in India in the face of

the Asian Financial Crisis and the recent Sub-prime Crisis and the consequential

world wide Banking crisis is laudable. The paper seeks to recount the historical

backdrop of the evolving Regulatory and Supervisory role of the Reserve Bank

of India. In the post reform scenario in the Banking Industry, the impact of risk

based and innovative supervisory tools employed by the Reserve Bank of India

were discussed. Analysis of secondary data obtained from the Reserve Bank of

India publications demonstrate the efficacy of the measures initiated by the

Reserve Bank of India.

Introduction:

The most recent crisis in the Banking History is the Sub-Prime fiasco which

resulted in the Global Financial Crisis and destabilised the economies of many

countries. The global economic outlook suddenly deteriorated and in fact the

Global GDP shrunk during years 2008-2009. United States, Europe and Japan

have gone into recession and the contagion effect has spread to most other

countries (Duvvuri Subba Rao, RBI Governor) . This is by far the worst crisis

since the 70s. There were Banking Crisis since the 90s for example the

Norwegian Banking Crisis in 1990-91,Japanese Banking Crisis during 1991-92,

Mexican Crisis in 1995, Asian Crises during 1997-98, the Russian , Argentinian,

and Turkish Banking Crisis in 2000. In comparison, the Indian Banking Sector

remained unscathed barring sporadic instances of Bank failures like the Global

Trust Bank, where too thanks to the urgent initiatives of the Reserve Bank and


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the Finance Ministry there was no contagion effect and things have been

sorted out so eminently. The role of the Reserve Bank of India in setting

Governance and compliance standards in the Banking Sector is laudable. The

way in which Reserve Bank responded to the challenges of the re cent Global

Financial Crisis, and its effect on India has demonstrated once again that theIndian Banking system is robust and resilient.

Objectives of the Study:

The present study is undertaken to analyse the efficacy of the measures taken

by the Regulator of the Banking System in India i.e., the Reserve Bank of India

to regulate and supervise the Banking system, and whether these measures

have enabled the Banks to perform better and be placed on par with

International Standards in terms of the known solvency and profitability

parameters.

Central Banking in India: Historical Perspective:

Banking supervision has assumed great significance in modern times throughout the world and it has become particularly important in developing

economies like India, as a sound Banking System is a sin-quo-non for orderly

growth of the economy. Banking regulation and supervision have evolved over

a period of time since the development of Commercial Banking in India which

can be traced back to the 18th

Century. The earliest Banks in India were Bank

of Calcutta which was established in 1806. The next major development in

Commercial Banking was the establishment of Bank of Madras in 1843 by

amalgamating four smaller Banks viz., Madras Bank, Carnatic Bank, Bank of

Madras and the Asiatic Bank. The British have also set up Bank of Bombay in

1868. These Banks were called the Presidency Banks and were amalgamated

during 1921 to become the Imperial Bank of India. Imperial Bank functioned as

a Commercial Bank, a Bankers Bank and Banker to the Government. The

Imperial Bank was functioning as the Central Bank of the country till the

formation of the Reserve Bank of India in 1935.


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SUPERVISORY AND REGULATORY FRAME WORK

The regulatory and supervisory functions of the Banking system were not

defined properly till the establishment of the Reserve Bank of India which

created confusion. The presidency Banks were regulated and governed by

Royal Charter and the government of India. The Company legislation did not

cover the Banking Companies. This lack of proper regulatory and supervisory

framework lead to major Bank failures undermining the confidence of the

public. The first systematic study of the Banking regulation and supervision

was conducted by the Central Banking Enquiry Committee (1929-31).

Important legislations covering the Banking Supervision aspects were the

Banking Companies (Inspection) Ordinance 1946, Banking Companies

(Restriction of Branches) Act 1946 and the Banking Companies Act 1949

applicable exclusively to the Banking Companies. This act has later become the

Banking Regulation Act from March 1966. By now the powers of the Reserve

Bank became well defined. The Reserve Bank of India became the repository

of all the regulatory and supervisory powers including the inspection of banks,

liquidity of the banks, management of banks, amalgamation, reconstruction

etc.

This the Banking Supervision in India evolved over a period of time as the

Government has started realising that a well regulated Banking system isnecessary for safeguarding the interests of the Depositors and to ensure the

allocative efficiency of the financial system to fulfil the growth objectives.

During the pre reform period from 1970 to 1980 due to practices like the

administered rates of interest, govt. directed lending etc. RBIs supervision was

not very effective. It is only in the post reform period, the RBI became very

innovative in evolving risk based methods and implemented them effectively.

CHANGING LANDSCAPE OF SUPERVISION FROM MICRO TRANSACTION BASED

TO MACRO RISK BASED APPROACH:Keeping in view the changing dynamics of Banking world over and within the

Country in terms of stupendous growth in the volumes of transactions, growth

of innovative Banking products, growing use of Tec hnology in the management

of Banks, the complexities of market risks and exposures to various

participants, Reserve Bank has been proactively improving its governance and


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supervisory techniques. However, the traditional macro approach was found

to be less effective and so recourse has been taken to other Risk based

supervisory methods in a phased manner.

The modalities of exercising regulation and supervision over Banks have

evolved over the decades in tandem with the market and technological

developments(V.Leeladhar, Dy. Governor, RBI)

The traditional methods of governance and supervision during the 80s were

the system of Annual Appraisal of Banks which are purely based on -site

Inspections. During the 90s the system of group-wide supervisory oversight

was adopted. The system of off-site monitoring of banks was introduced in

1995. Gradually the supervisory rating models like the CAMELS AND CALCS

were also developed by the Reserve Bank to provide a risk based summary

view of the overall health of indiv idual Banks. Another important milestone in

the Risk Based approach to Banking supervision was the introduction of

Prompt Corrective Action (PCA) Frame Work. The PCA framework enables

timely intervention of the Reserve Bank of India when the soundness

parameters like the Capital Adequacy, Asset Quality and the Return on Assets

deteriorate. The Board for financial Supervision was constituted under the

Chairmanship of the Governor of the Reserve Bank of India which played a very

important role in securing the orderly supervisory oversight of Banks.

RISK MANAGEMENT SYSTGEMS IN BANKS

The shift from transaction based supervision to Risk based Supervision was

necessitated due to the complexity of modern times. The most important of

the risks viz., Credit Risk, Market Risks(Interest Rate Risk, Foreign Exchange

Risk, Liquidity Risk), Operational risk(People Risk, Control Risk, IT Risk,

Legal/Regulatory Risk, Reputational Risk) need deft planning and careful

handling by the Banks. The Supervisory mechanism too needs to upgrade their

skills for prompt detection of the failure of the Risk Ma nagement systems.

Reserve Bank over a period of time has guided and insisted on the putting in

place proper Risk Management Systems in Banks.


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It is to the credit of the Indian Regulatory Agencies like the Reserve Bank of

India, Securities Exchange Board of India, IRDA etc. that the Indian Financial

System remained comparatively unscathed despite the catastrophic failures of

the financial systems elsewhere in the world.

The evolvement of financial instruments and markets has enabled Banks to

undertake varied risk exposures. In the context of these developments and the

progressive deregulation and liberalisation of the Indian Financial Sector,

having in place effective risk management and internal control systems has

become crucial to the conduct of Banking business. This is also significant in

view of the introduction of the New Basel Capital Accord under which capital

maintained by a Bank will be more closely aligned to the risks undertaken.

Further Internet Banking, E-Commerce, E-Money and other Information

Technology related Innovations are adding new dimensions to Risks faced by

the Banking Sector. Mergers and acquisitions as well as outsourcing of some

non-core activities are undertaken by the Banks with some strategic objectives.

They also enhance the Risks in Banking.

The objectives of the Risk Management can be summarised as disaster

prevention by setting Capital Adequacy Standards and prudential limits. This

will lead to allocation of supervisory resources in accordance with the risk

profile prepared by the Bank and focuses on areas exposed to greater risk. For

the Bank supervised this may result in less supervisory intervention. As the

focus would shift from transaction based audit and inspection to systems,

Banks would be encouraged to develop systems and procedures and

understand and perceive awareness of risks more accurately .Under the new

approach the Audit methodology also will undergo a radical change. The

Internal Audit of the Banks will now be Risk based so as to make it more

forward looking with emphasis on identification of potential risks if any with

suggestions for risk mitigation.

IMPACT OF THE MEASURES INITIATED BY THE RESERVE BANK OF INDIA:

The stupendous growth of volumes in business could be appreciated if one

looks at the statistics relating to Commercial Banks in India as published by the

Reserve Bank of India. The no. of Bank offices in India which was 8262 as on


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June 1969 has grown to 67157 as on March 1999 and to 72000 by 2008. The

aggregate Deposits as on June 1969 which stood at a mere Rs.4646 crores has

shot up to Rs.722203 crores as on March 1999 and to further Rs.2109049

crores as on March 2006. As on March 2010 the aggregate deposits of

Scheduled commercial Banks stand at Rs.4492826 crores (Table 47:Hand bo okon statistics on the Indian Economy.) The population per Branch office of Banks

which stood at 64000 has steadily come down to around 15000 and remained

at this during the post-reform period.

--InsertRisk weighted Capital Adequacy table


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Table 3.15 : Banking Indicators Select CountriesRegion Banks Provision to Non-Performing Loans Bank Return on Assets(per cent) (per cent)

2007 2008 2009 Latest 2007 2008 2009 Latest1 2 3 4 5 6 7 8 9Latin AmericaArgentina 129.6 131.4 123.0 November 1.5 1.6 2.4 NovemberBrazil 181.9 189.0 156.0 October 2.9 1.5 1.2 OctoberChile 210.2 179.9 177.5 December 1.1 1.2 1.2 December

Mexico 168.9 161.2 163.8 September 2.7 1.5 1.2 SeptemberEmerging EuropeHungary 64.8 58.9 51.2 September 1.2 0.8 1.1 SeptemberPoland - 61.3 50.2 September 1.7 1.6 1.2 SeptemberRussia 144.0 118.4 94.8 December 3.0 1.8 0.7 DecemberAsia

China 39.2 116.4 155.0 December 0.9 1.0 1.1 JuneHong Kong SAR 78.4 71.5 68.3 September 1.9 1.8 1.6 SeptemberIndia 56.1 52.6 - March 0.9 1.0 1.0 March

Indonesia 104.5 118.6 127.4 April 2.8 2.3 2.6 SeptemberKorea 205.2 146.3 125.2 September 1.1 0.5 - DecemberMalaysia 77.3 89.0 93.3 November 1.5 1.5 1.2 September

Philippines 81.5 86.0 91.4 September 1.3 0.8 1.1 SeptemberSingapore 115.6 109.1 91.0 September 1.3 1.0 1.1 SeptemberThailand 86.5 97.9 - December 0.1 1.0 - December

Advanced EconomiesAustralia 181.8 74.8 68.0 September 1.0 0.7 0.6 JuneCanada 42.1 34.7 59.1 September 0.8 0.4 0.4 SeptemberJapan 78.3 83.2 83.2 September 0.3 -0.2 0.2 September

United States 91.7 75.3 58.1 December 0.8 0.0 0.1 DecemberSource: IMF, GFSR, April 2010.

As a result of the regulatory and supervisory initiatives of the Reserve Bank of

India, there is marked improvement in the operational performance and

soundness of the Banks as reflected in the statistics compiled by the Reserve

Bank of India. Analysis of the statistics relating to capital adequacy ratio of

Commercial Banks in India makes an interesting reading as to how the Reserve


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It is felt that on occasions like this when we speak of Leadership through

Governance, while there will be many individual leaders, and institutions

emerging as leaders, the role of the Reserve Bank of India in the sphere of

Leadership and Governance should be definitely remembered. It i s the culture

and the steadfastness with which the Reserve Bank ha assiduously pursued thegoals of attaining International Standards in Governance and Regulation of the

Banks that has secured for the Country a Sound and Resilient Banking system.

REFERENCES:

Bank for International Settlements (BIS) Working Papers.

Basel Committee on Banking Supervision-various publications

Report of the Financial Stability Forum, Basel

Prudential Bank Regulation: Whats Broke and How To Fix ItCharles W. CalomirisApril 2009

Banking on the Principles: Compliance with Basel Core Principles

and Bank Soundnessby Asl Demirg-Kunt, Enrica Detragiache, and Thierry Tressel1

September 2006

Andersen, Palle S and William R. White : The Macroeconomic Effects of

Financial Sector Reforms: An Overview of Industrial Countries.

Reserve Bank of India publications more importantly the following:

Quarterly RBI Bulletin

Banking Review Annual Number,2009

Bank for International Settlements (2008), 78th

Annual Report, 2007-08


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Committee on Global Financial System (2009), Capital Flows andEmerging Market Economies (Chairman: Rakesh Mohan), CGFSPapers No 33, Bank for International Settlement.

de Larosiere Report (2009), Report of the High-Level Group on

Financial Supervision in the EU (Chairman: Jacques de Larosiere),Brussels.

Geneva Report (2009), The Fundamental Principles of FinancialRegulation, Geneva Reports on the World Economy 11 (by MarkusBrunnermeier, Andrew Crocket, Charles Goodhart, Avinash D. Persaudand Hyun Shin).

G-20 (2009), Working Group on Enhancing Sound Regulation andStrengthening Transparency (Co-Chairs: Tiff Macklem and Rakesh

Mohan).

Group of Thirty (2009), Financial Reform: A Framework for FinancialStability (Chairman: Paul A. Volcker), Washington D.C.

Reddy, Y.V, (2008), Global Financial Turbulence and Financial Sectorin India: A Practitioners Perspective, Reserve Bank of India Bulletin,August.

Taylor, John (2009), The Financial Crisis and the Policy Responses: An

Empirical Analysis of What Went Wrong, Working Paper 14631,January, National Bureau of Economic Research.

Turner Review (2009), The Turner Review: A Regulatory Response tothe Global Banking Crisis by Lord Turner, Chairman, Financial ServicesAuthority, UK.

Yellen, Janet L. (2009), A Minsky Meltdown: Lessons for CentralBankersavailableat http://www.frbsf.org/news/speeches/2009/0416.html

Reserve Bank of India (2005a): Report on Currency and Finance: 2004-05,Mumbai: Reserve Bank of India.

Reserve Bank of India (2005b): (History of) Reserve Bank of India (3volumes),Mumbai: Reserve Bank of India.


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Reports of the Narasimhan Committee on Banking Reforms I and II

Internal Audit in Banks and the supervisors relationship with auditors

Working Paper of Basel Committee on Banking Supervision.

Dr.Y.V.Reddy Monetary and Financial Sector Reforms in India UBSPublications, New Delhi

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