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 70’s. There were Banking Crisis since the 90’s 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
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 recent Global
Financial Crisis, and its effect on India has demonstrated once again that the
Indian 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 through

out 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 Banker’s 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.
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 is
necessary 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. RBI’s 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 Technology in the management
of Banks, the complexities of market risks and exposures to various
participants, Reserve Bank has been proactively improving its governance and
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 80’s were
the system of Annual Appraisal of Banks which are purely based on-site
Inspections. During the 90’s 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 individual 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 Management systems.
Reserve Bank over a period of time has guided and insisted on the putting in
place proper Risk Management Systems in Banks.
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
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 book
on 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

Table 3.15 : Banking Indicators – Select Countries
Region Banks’ Provision to Non-Performing Loans Bank Return on Assets
(per cent) (per cent)
2007 2008 2009 Latest 2007 2008 2009 Latest
123456789
Latin America
Argentina 129.6 131.4 123.0 November 1.5 1.6 2.4 November
Brazil 181.9 189.0 156.0 October 2.9 1.5 1.2 October
Chile 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 September
Emerging Europe
Hungary 64.8 58.9 51.2 September 1.2 0.8 1.1 September
Poland - 61.3 50.2 September 1.7 1.6 1.2 September
Russia 144.0 118.4 94.8 December 3.0 1.8 0.7 December
Asia
China 39.2 116.4 155.0 December 0.9 1.0 1.1 June
Hong Kong SAR 78.4 71.5 68.3 September 1.9 1.8 1.6 September
India 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 September
Korea 205.2 146.3 125.2 September 1.1 0.5 - December
Malaysia 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 September
Singapore 115.6 109.1 91.0 September 1.3 1.0 1.1 September
Thailand 86.5 97.9 - December 0.1 1.0 - December
Advanced Economies
Australia 181.8 74.8 68.0 September 1.0 0.7 0.6 June
Canada 42.1 34.7 59.1 September 0.8 0.4 0.4 September
Japan 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 December
Source: 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
Bank of India has been able to achieve international standards for the Indian
Banking system. There were atleast 8 Banks whose capital adequacy was less
than 4%, 9 Banks with capital adequacy between 4-9% and 33 Banks between
9-10%, this figure has been gradually brought down to 3,2 and 11 by 2000-01
and to 1, 1 and 8 by 2004-05. The present position is that without exception all
Scheduled commercial Banks in India are Basel II compliant as regards capital
adequacy ratio. As on March 2009 the average capital adequacy percent stood
at 13.2.There is similarly a marked improvement in regard to asset quality.
During the pre-reform period of 1996-97 the Gross NPLs(Non Performing
Loans) as a percentage of Gross NPLs was 15.7% which was reduced to 12.7
during 1999 and to 5.2 by 2004-05. The ratio of NPAs for corresponding
periods is even better. This was 8.1%, 6.2% and a mere 2% for the
corresponding period. The stringent application and monitoring of the Income
Recognition and Asset Classification Norms brought about these improvements
putting Indian Banks on par with their peers internationally. As on March 2009
the Gross and Net advances of Scheduled Commercial Banks is Rs.3038254
crores and Rs.3000906 crores. The Gross NPAs as a percentage of Gross
Advances is 2.3, and NPAs as a percentage of total advances is a mere 1.3.
(Table 64 of Handbook of Statistics on Indian Economy)

The ratios relating to profitability of the Banks reveal similar improvement.

The cost to income ratio and the spread of Scheduled Commercial Banks has
registered improvement. The select Productivity Indicators of Scheduled
Commercial Banks in terms of Business per employee and Profit per employee
have shown highly satisfactory position. For example the Business per
employee during 1992 which was 5.4 million has gone upto 8 4 million during
1999 and by 2004 it reached 16.3 mio. Similarly profit per employee which
stood negative during the pre-reform period has improved to 0.15 mio during
2004. The figures for per Branch business for these periods remained at 109.9
mio, 158.7 mio and 254.5 mio respectively.

Conclusion:
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 is the culture
and the steadfastness with which the Reserve Bank ha assiduously pursued the
goals of attaining International Standards in Governance and Regulation of the
Banks that has secured for the Country a Sound and Resilient Banking system.

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