The move of the RBI to monitor and evaluate the functioning and work of rating agencies is most welcome.Rating agencies have a tendency to give excellent ratings to new issues,new products,new derivatives etc of powerful corporates to enhance their earnings and expand their business.In the U.S rating agencies have caused untold damage to the economy by giving good rating to all sorts of innovative products and derivatives based on which banks in US made investments in derivatives backed by all sorts of loans including sub-prime loans..Such thing should not be replicated in Indian economy.RBI has taken this initiative in order to prevent U.S type of ratings that may misguide and prompt all banks to invest in all sorts of derivatives.This is an excelent preventive measure.Indian banks are stronger and more resilient than those in other countries because of the reforms implemented here.Banks must continue to be strong and healthy and their investments must be healthy too.From this angle the RBI initiative is most welcome.
It is better if the RBI and SEBI take steps to establish a separate regulator for rating agencies in India.
Monday, April 27, 2009
Monday, April 6, 2009
BANKING AT ITS BEST THROUGH BEST PRACTICES
Introduction:
Indian Banking sector has undergone a thorough change and remarkable transformation during the last 17-18 years. The banking reforms implemented on the basis of the blue print provided by Narasimhan Committee and other wide ranging supportive measures initiated and implemented by Government of India and RBI have contributed significantly to the enhancement of financial strength intrinsic soundness resilience and operational efficiency of banks. Banks in India have been showing stronger balance sheet footing with better asset quality in post reform period. The post-reform period has also witnessed advent of new players ,product innovations and introduction of new instruments and new approaches to aggressive marketing of such new products . Banks presently operate in an increasingly deregulated and market driven competitive environment of operational flexibility. We are also aware that there has been constant strengthening of financial supervision and prudential regulation over banks in India. With re-inforced strength and stronger financials Indian Banks are now capable of taking advantage of increasing business opportunities both domestic and global .Availment of such expanding opportunities particularly those arising out of expanding financial inclusion as well as those available at the bottom of the pyramid and new global opportunities will facilitate further growth of banks with business diversification.
Indian banks have been able to achieve good results on a wide front in spite of adoption of and adherence to prudential norms relating capital adequacy ,asset classification ,income recognition and provisioning and other regulatory norms and guidelines and implementation of the social objectives of achieving priority sector lending targets and directing credit to weaker and neglected sections of society.
It is indeed gratifying to note that the overall capital adequacy ratio of Indian banks increased to 12.3 per cent towards the end of March 2007 from 10.4 per cent in March 1997. The asset quality as reflected in the reduction in net NPA rate has also improved significantly. The ratio of NPAs to net advances declined to 2 per cent towards the end of March 2007 from 8.1 per cent in March 1997. The profitability of banks as reflected in the rate of return on assets (ROA) increased from 0.7 per cent to about 0.94 per cent in the same period. In a globalised and increasingly integrated world it is essential that our banking system must strictly adhere to global best practices and sound globally recognized performance benchmarks and aim at the achievement of sound financials and other soundness, strength and health indicators used at global level for performance evaluation purposes.
Triple objectives
.Banks must derive value- adding performance to fulfil the expectations of all stake holders It is also necessary to achieve Proper and smooth integration of domestic banking and financial system with global financial system. Also it is important to build up and strengthen financial infrastructure and banking system within the country. These can be considered triple objectives in the present day context . These triple objectives are sought to be achieved by means of observing universally recognized best practices.. Banks can surely show better, stronger sounder enduring and value-adding performance and undertake banking at its best in terms of quality of assets and return on assets return on equity .earnings and profitability financial strength and fundamentals ,minimization of costs ,enhancement of wealth for stake holders etc through adoption and implementation of internationally accepted best banking practices ,standards ,codes and other globally accepted performance bench marks and optimum performance indicators. Banks must give primacy to the achievement of above dual objectives.
Guided by above considerations it is absolutely essential for Indian banks to strictly adhere to global best practices and global performance benchmarks and performance indicators in different areas.
Global best practices refer to global standards bench marks and target performance levels set by international financial institutions and other organizations including Basel Committee on Banking Supervision (BCBS). These best practices have been arrived at after lot of thinking ,discussion and deliberations and based on the evaluation of the weaknesses and deficiencies which brought about financial crisis in the past. These best practices and standards cover certain relevant aspects and areas in the financial system. Their importance emanates from the fact that they contribute significantly to sound and strong financials and solid fundamentals, help strengthen financial regulation and bring about required measure of transparency, apart from contributing to the healthy development of the institution concerned..
Adoption and implementation of best practices in different areas may surely go a long way in reducing vulnerabilities of banks and financial institutions. They also provide a basis for informed decision making in different areas particularly in lending and investments. If properly used they can assist in minimizing risks of of different types... They can play an important role in bringing about uniformity and some sort of standardization of practices among all banks and financial institutions in different countries in the world. They facilitate comparative evaluation and assessment by serving as bases or bench marks with reference to which reviews and assessment can be made.
Risk Management Practices:
Risk management is by far the most important area to be covered under global best practices and standards. In the present complex environment and competitive set up the success of any financial institution depends on its risk management capabilities. Success will come only if we assess risks correctly price them properly and manage them effectively. It is always necessary to restrict or limit losses from different transactions. By means of this strategy every bank has to control and regulate its overall exposure to different areas. What banks need to-day is a strong pro-active risk management strategy which helps avoid high risks and ensures that risks are taken consciously and after perceiving all types of possibilities and with full knowledge of all facts and all aspects of the risk involved.. Basel II gives lot of importance to risk management. It is necessary for banks to clearly understand the nature of risk involved in every area of activity and in all lendings and credit exposures both fund based and non-fund based and also in investments. It is also necessary to adopt systems for measurement of performance not only in accounting terms such as return on assets (ROA) return on equity (ROE) etc, but also, for measuring the shareholder value and shareholder wealth created from time to time. It is therefore, necessary to use measures and yard sticks such as risk adjusted return on capital (RAROC) and other available measures for the purpose of assessment and evaluation..
To facilitate comprehensive evaluation and assessment banks may group or categorise customers into segments or business groups such as corporates, retail trade units ,service sector units ,housing finance companies whole sale,trading units ,manufdacturing units small business professionals and self-employed, SMEs, etc and fix a target for return or maximum return expected from each of such categories .Banks must review performance in terms of return from time to time with reference to the targets fixed for each group . If the review reveals that a particular segment or category has given a return higher than the target originally fixed for the category it is clear that that group has given something to value addition in the form of extra or excess return over the target fixed.. Capital allocation may be done having regard to what each group has given by way its contribution in relation to the target as revealed by the review. Risk adjusted performance measurement and evaluation helps in the matter of alignment of objectives at the level of each category or segment and also at the aggregate level i.e. the overall level in the bank. Adoption of such comprehensive risk management system will help banks in the process of capital allocation to different businesses and activities based on risk adjusted performance and return from each one of them. As Indian banks move progressively towards globally recognised best practices with integration of risk management in to the business process use of the yard sticks like RAOC and other measures of evaluation will greatly help in pricing decisions as well as in measurement of performance of different business segments and capital allocation to various segments and overall capital management. Consequent on the shift from capital adequacy to capital efficiency now banks have got to focus on efficient capital management capital saving and over all balance sheet management.
Best Practices for Combating Terrorism and Customer Risk Assessment
Banks have to adopt globally recognised best practices for combating terrorism and also for evaluating customer risk by adopting and implementing Anti Money Laundering Policy and programme..
. The AML policy to be adopted and implemented must match global standards. In to-day’s globalised environment organised crime groups which generate huge amounts of money through drug trafficing arms smuggling and other financial crimes may project such dirty and illegal money as legally and legitimately acquired money by means of moving the same through financial system and banking channels. Such dirty and illegal money may be transferred from one country to another for being used for terrorist activities. As a part of the global efforts at fighting money laundering and terrorist financing India has enacted Prevention of Money Laundering Act, 2002 which came into force on 1st July 2005 Recently Prevention of Money Laundering[Amendment]Bill 2008 has been adopted and this may become an Act soon. This amendment aims at checking use of illegal money for financing terror .Money changers and ,money transfer service providers are brought within ambit of this law.. India has set up Financial Intelligence Unit – India (FIU – India) in 2005. This unit collects reports regarding cash and suspicious transactions from banks and other reporting organizations analyses them and disseminates the findings and results to various law enforcement agencies for necessary action. This unit also interacts with FIUs of other countries and gathers information regarding best practices and arranges for exchange of information. Hence, every bank has to adopt a suitable AML programme and policy. Every bank must communicate to the staff at all levels the AML standards and procedures that the bank has adopted. The AML policy should also indicate the AM.L operating structure regulatory reporting and recording requirements and inspection and audit and monitoring mechanism that will be employed to ensure strict adherence to AML requirements. International standard setters such as Basel Committee and Financial Action Task Force (FATF) have done lot of work to prescribe comprehensive guidelines regarding opening of accounts, customer identification and know your customer requirements and risk management apart from customers due diligence process for financial institutions.
The Financial Action Task Force has come out with 40 recommendations which provide a comprehensive blue print for action to be taken and strategy to be adopted for preventing the use of the financial system for money laundering. Global best practices for combating money laundering require banks to develop clearly spelt out customer acceptance policies and customer identification procedure, covering description of categories of customers that are likely to pose higher than average and normal risk to banks. By adopting graduated and comprehensive customer acceptance policies and customer identification procedure banks can conduct more extensive and enhanced due diligence for customers with higher risk. The RBI has given freedom to banks to compile their own risk profiles of customers based on relevant parameters. Banks can use parameters such as geographical areas or locations, range of products and services, type of business, manner of funding the account etc for evolving its own risk profile of customers. However, risk profiling needs to be well documented so that the parameters can be well demonstrated to the regulators whenever called upon to do so.
It is necessary for banks to ensure that risk profiles are compiled and preserved for each customer at the time of commencement of relationship.
Inclusive BankingPractices
However, the customer acceptance policies must not be too restrictive resulting in denial of access to banking services to the people, particularly to the weaker and disadvantaged sections of society .Access to financial services is one of the enablers for participation in the efforts at development of the national economy. Restrictive policies may come in the way inclusive banking practices adopted by banks. Hence, adequate care has to be taken to ensure that there are no restrictive clauses in the policy resulting in denial of access to banking products and services to any category of people. Enhanced and quite extensive process of due diligence is required in the case of politicians, high net worth individuals known criminals etc and other categories of high risk customers. Developing and putting in place suitable systems of monitoring is very essential for identification of suspicious transactions throughout the period of relationship with a customer.
Reports regarding cash transactions of over Rs.10 lakhs and suspicious transactions should be generated and sent to concerned authorities. The Prevention of Money Laundering Rules 2005 have provided a definition of what constitutes suspicious activity and the procedure for reporting to the Financial Intelligence Unit (FIU) Government of India. The RBI has issued detailed guidelines to banks incorporating therein best practices in this regard and spelling out how banks have to handle the issue relating to account opening risk management reporting of cash transactions reporting of suspicious transactions to FIU (India) maintenance of records training of staff, etc. RBI has provided certain concessions and relaxations in obtaining documents by banks particularly in rural and semi urban areas. In the case of no-frills accounts KYC requirements are relaxed further to facilitate faster financial inclusion of people in rural areas.
RBI has also stressed the need for customer education regarding the importance of submission of prescribed documents at the time of opening the accounts and commencing the relationship. Banks must do their best in creating public awareness in this regard and educating the customers regarding all aspects of customer identification including submission of required documents.
Corporate Governance Practices:
Another important requirement for banks is adherence to good corporate governance philosophy and practices which must be based on an effective and independent board.. .The recent Satyam episode has shown how failure of corporate governance can cause the decline and downfall of any reputed corporate entity .The corporate governance philosophy of any organization must be based on high standard of universally accepted ethical values and disciplined approach to management .Accountability commitment ,integrity ,transparency justice .,and fairness in all activities must be hall marks of management at board level .Principles of corporate governance have now become some sort of conventional wisdom and banks have to go by this wisdom scrupulously .Corporate governance can be an effective tool for toning up the economic health and intrinsic soundness of any corporate entity .The most important objective of corporate governance is creation and enhancement of value for all stake-holders. Banks have to ensure highest ethical standards in the process of undertaking banking business activity with due diligence. Basel Committee has prescribed some important tenets and principles in this regard. These principles must be carefully adhered to .The corporate governance framework must be adequately flexible to facilitate fast response to changing market dynamics .At the same time it should be firm as regards its values and ethics The corporate governance philosophy must cover not merely regulatory ,statutory and ,legal aspects and requirements but also voluntarily accepted best practices across the world that may help attain high level of business ethics ,and maximization of value and welfare to stake holders..
The Consultative group on corporate governance headed by Dr.A.S.Ganguly has recommended that the boards must be made contemporarily professional by means of adherence to “fit and proper norms” in the matter of nomination of directors. The concerned authorities charged with the task of nominating directors must follow the fit and proper” norms and guidelines of RBI in this regard while nominating directors on the boards of banks Suitability of persons for appointment as directors must be assessed through due diligence The criteria to be followed must include qualification ,expertise track record ,integrity and other relevant fit and proper criteria.. The whole time directors must have sufficiently long period of stay as directors say three to five years to enable them to make some impact of their leadership and professional competence on the ’ performance of the bank concerned. .Directors have a responsibility to gather adequate information regarding the business and performance from time to time .Directors are expected to protect the interests of share holders .In vast majority of cases VIPs, legal luminaries and experts from different fields are inducted in to boards .Such directors must make use of their expertise and contribute significantly to the deliberations in board meetings so that sound decisions emerge on different matters at each meeting Directors must also try to provide a new perspective and new vision to board room. . VIPs and luminaries who are inducted as directors must try to create an impact instead of being directors for decorative purposes.
THRUST AREAS:
Boards of banks must concentrate on strategic planning policy formulation in respect of all vital areas such as credit ,investments ,international banking ,treasury and funds management organizational development human resources development ,issues relating to business expansion ,expansion of branch net work ,issues relating to technology. risk management systems internal control and issues concerning overall governance. These are areas of major thrust requiring prime concentration at board level.. The board must not waste time in discussing routine things and unimportant matters that can be handled at the level of bank executives..
Quality Practices- Attainment of excellence is the ultimate goal of quality practices to be adopted in any bank...
Banks must also observe best quality practices .Each bank must have a separate cell in planning department charged with the job of planning, building and institutionalizing quality across the bank .This cell can be set up in the planning department This cell can concentrate on quality improvements ,dissemination of information regarding quality creation of quality culture building up of knowledge capabilities so necessary for building up and development of quality and implementation of best quality practices .The cell must keep on studying the quality practices being pursued elsewhere and pick up and adopt the relevant and best ones in their respective institutions.
Best Compliance Practices:
Adoption of best compliance practices is another requirement of supreme importance. Compliance function in banks is an important element in the process of corporate governance and hence, there is a need to strengthen compliance management practices in all banks. According to Basel Committee on Banking supervision it is necessary for banks to have different committees such as, audit committee, management committee, risk management committee, remuneration committee, corporate governance and nomination committee, customer service committee . HR committee share transfer committee, committee for monitoring large value frauds, etc
The Audit Committee over sees reviews and provides directions to the internal audit/inspection function in the Bank in order to ensure and enhance effectiveness of audit and inspection functions as strong management tools The Audit Committee must focus on investment portfolio including debt and shares held with a view to finding out deterioration in value if any.. The committee also reviews all the issues raised in the Long Form Audit Reports. It also interacts with external auditors before finalization of Audited Accounts Management committee has the responsibility taking decisions on high value credit compromise and write off proposals etc Risk management committee identifies evaluates monitors and guides the Bank on various categories of risks to which bank is exposed and devices suitable strategies for managing credit market liquidity operational and legal compliance and reputation and other risks of the bank. Remuneration committee is charged with the job of providing oversight of remuneration of top and senior management and other key personnel performance linked incentives etc and ensuring that compensation is consistent with banks objectives, strategy culture and control environment. Nomination committee has to provide evaluation of effectiveness of board. It undertakes the process of due diligence for determining fit and proper status of existing elected directors and persons to be elected as directors compliance function is a vital function and forms part and parcel of governance in banks.
In the case of listed banks capital market related regulatory compliance must also be ensured. Other committees perform the functions relevant to them. The compliance function should ensure that existing prescribed procedures, guidelines system and controls capture the required information and data in order to facilitate discharge of risk management function at the board level. Compliance must start at the top. Compliance can be effective in a corporate culture where board assumes full responsibility for compliance. Bank Boards must ensure that a proper compliance policy is put in place and board should also oversee its implementation. A robust compliance system should be put in place along with a comprehensive compliance policy. Compliance policy must cover compliance philosophy of the bank role of chief compliance officer and compliance department and composition of its staff and their specific responsibilities. The Board may review the policy from time to time. The Board must also review compliance periodically. Bank boards may constitute compliance committee to oversee the compliance of all regulatory and reporting requirements as well as with banking laws, taxation laws, international laws, labour laws, accounting standards, anti-money laundering Act, fiscal Responsibility Act Right to Information Act and so on. Non-compliance of any of the laws will entail financial and reputation risk to the Bank.
Transparency Practices
The next important requirement is transparency and disclosure in financial statements. The data and details given in financial statements must be adequate to ensure adequate measure of transparency. This enables the public at large and customers to evaluate financial position and performance of the bank. The disclosures are useful to the public in assessing and understanding where exactly the bank stands in relation to their expectations and in in making decisions regarding choice of banks for keeping their deposits and also for other banking needs. The users of financial statements are interested in the liquidity and solvency and risk in respect of assets and liabilities figuring in and recognised on the Balance sheet of the bank and also off balance sheet items of the bank.. Banks may do well to explain the way they manage and control risks associated with the operations of the bank. Banks may provide commentary and notes on the financial statements for clarity of understanding. The generally accepted accounting principles and standards must be followed. The Auditing and Assurance Standards Board of the Institute of Chartered Accountants of India has issued as many as 35 standards which must be followed.
The next vital requirements is assessment of position with reference to Industry best practices. Assessment of best practices involves analysis of the organisation’s processes, work flow planning process and strategic planning staffing, major areas such as retail delivery sales CRM strategy and CRM operations human resources finance and funds management investments management and accounting. The objective of this assessment is to reduce current operating expenses, improve productivity to avoid future cost increases, increase returns and revenue, improve quality of service delivery and position the bank for continued growth and expansion. Best practices provide bench mark for market participants to operate efficiently. But, their implementation must be suitable to country specific priorities and circumstances.
As rightly stated by Dr Y V Reddy, Past Governor of RBI, “the implementation of standards must fit into a country’s overall strategy for economic and financial sector development taking into account the stage of development, level of institutional capacity and other domestic factors”. The Standing Committee on International Financial Standards and Codes monitors developments in global standards and codes and looks into applicability of these standards to Indian Financial System. The approach of RBI to the adoption and internalisation of global best practices prudential norms and standards and codes in respect of Indian banks is one of slow,steady and gradual shift and convergence with international standards and best practices with apposite and required changes so as to make them relevant to banks in India..
PRACTICE OF DHARMA and Fair Practices.-
All activities ,operations and over all governance must be guided by dharma and tenets of dharma. .Banks must follow the fair practices contained in the code of commitment to customers .The objective of the code is to promote good and fair practices by setting minimum standards in dealing with customers and to provide full information to customers regarding products and ,services so as to enable them to take informed decisions .Enhancement of transparency ,to encourage market forces through competition ,to achieve high operating standards to promote fair and cordial relationship between the bank and customers and to foster confidence in the bank concerned and the banking system in general are other objectives of the code.
The code must apply to all products and services offered by banks .Products and services offered by banks must conform to relevant laws and rules as well as regulations .The dealings of banks with customers must rest on ethical principles of integrity ,and transparency .Banks must help customers by providing regular updates and by keeping them informed about changes in interest rates ,charges or terms and conditions .Banks must rectify mistakes in rates applied or in other calculations promptly and reverse charges applied by mistake if any promptly .Also banks must attend to customer complaints speedily and redress them expeditiously .Banks must practice non-discrimination policy .There must be no discrimination on the basis of religion ,caste creed ,race sex physical disability etc Full transparency regarding rates of interest processing charge and other charges etc must be ensured .Changes in rates of interest and fees payable must be communicated to parties concerned by display of suitable notice on notice board ,or some other means of communication .All advertisements and publicity material must be clear and there must be no ambiguity .All personal information regarding customers must be treated as private and confidential even after cessation of relationship except in cases where information has to be given as per law or by way of duty towards public and in public interest .While granting loans banks must explain repayment process by way of amount ,tenure ,periodicity of payment preclosure penalty if any and representatives authorized to collect repayments must adhere to prescribed guidelines .Privacy of customers must be respected .Interaction with customers must be in very civil manner .During recovery visits decency and decorum must be maintained .Customers must be contacted ordinarily at the place of his or her choice and in the absence of specified place at residence and if unavailable at residence at the place of business .Identity and authority of the person to represent the bank must be made known to the customer .Thus all the fair practices contained in the code must be adhered to by banks .By adhering to code of commitment ,fair practices and tenets of dharma banks can enhance their public image and win customer loyalty and customer commitment which will go a long way in helping banks in business expansion and business performance.
Practice of Adhering to Globally Recognised Performance Indicators and Bench Marks.
It is also necessary for banks to try to achieve global bench marks in diverse areas such as capital adequacy ratio return on assets, net interest margin cost income ratio non-performing loans ratio, provisioning of non-performing loans ratio, capital asset ratio, funding volatility ratio, etc. Banks must on an on-going basis review their performance in attaining the highest ratios with reference to the ratios obtaining in other countries and also with reference to the globally accepted best ratios.
Each bank must institute a system of review of their performance in these areas with reference to the highest ratios in these areas achieved by banks in India as well as other developed countries and also with reference to the overall global position. On the basis of reviews from time to time banks must initiate necessary measures to improve the performance in the areas where performance is found inadequate in relation to global ratios performance indicators and bench marks. These reviews must be made at the highest level in management including the board level.
Simultaneous Achievement:
Indian banks must continue to perform well and continue to give excellent financial results while simultaneously contributing substantially by way of value to stake holders. At the same time, they have to discharge the social obligations cast upon them and fulfil the expectations of society. All these can be simultaneously achieved only by means of strict adherence to global best practices, global standards and codes and global bench marks and other performance and soundness indicators explained earlier. Best practices may keep on changing and evolving over time across the world and banks must be constantly alive to the changes and developments in this regard from time to time. It will always be prudent for banks to adopt a pro-active approach in the matter of adoption of best practices. Each bank may create a global best practices cell in the corporate office for the purpose of studying the developments and evolution of best practices elsewhere for the purpose of facilitating adoption of a pro-active approach apart from implementing the guidelines ,and directions issued from time to time by RBI regarding best practices to be observed.
The above cell can be charged with the job of studying the domestic developments as well as developments across the world in the area of best practices. It should also evaluate the performance of the bank in achieving global bench marks in different areas and other performance and soundness indicators with reference to the attainments in the concerned areas in other advanced countries and at global level and place the results and findings of the review before the top management and the Board of directors. Based on such reviews banks can take required steps for fine tuning the implementation of best practices, strategies, processes and other aspects of functioning with a view to achieving better operational and financial results and higher value for stakeholders. Banks have thus got to aim at banking at its best in terms of quality of service to customers ,maximization of earnings ,and profits and creation and enhancement and maximization of value for the stake holders minimization of risks to the lowest level possible implementation of norms standards ,and regulatory requirements to the satisfaction of regulators fulfillment of social objectives and fulfillment of the expectations of society. All these can be achieved only by means of strict adherence to and observance of best practices.
Indian Banking sector has undergone a thorough change and remarkable transformation during the last 17-18 years. The banking reforms implemented on the basis of the blue print provided by Narasimhan Committee and other wide ranging supportive measures initiated and implemented by Government of India and RBI have contributed significantly to the enhancement of financial strength intrinsic soundness resilience and operational efficiency of banks. Banks in India have been showing stronger balance sheet footing with better asset quality in post reform period. The post-reform period has also witnessed advent of new players ,product innovations and introduction of new instruments and new approaches to aggressive marketing of such new products . Banks presently operate in an increasingly deregulated and market driven competitive environment of operational flexibility. We are also aware that there has been constant strengthening of financial supervision and prudential regulation over banks in India. With re-inforced strength and stronger financials Indian Banks are now capable of taking advantage of increasing business opportunities both domestic and global .Availment of such expanding opportunities particularly those arising out of expanding financial inclusion as well as those available at the bottom of the pyramid and new global opportunities will facilitate further growth of banks with business diversification.
Indian banks have been able to achieve good results on a wide front in spite of adoption of and adherence to prudential norms relating capital adequacy ,asset classification ,income recognition and provisioning and other regulatory norms and guidelines and implementation of the social objectives of achieving priority sector lending targets and directing credit to weaker and neglected sections of society.
It is indeed gratifying to note that the overall capital adequacy ratio of Indian banks increased to 12.3 per cent towards the end of March 2007 from 10.4 per cent in March 1997. The asset quality as reflected in the reduction in net NPA rate has also improved significantly. The ratio of NPAs to net advances declined to 2 per cent towards the end of March 2007 from 8.1 per cent in March 1997. The profitability of banks as reflected in the rate of return on assets (ROA) increased from 0.7 per cent to about 0.94 per cent in the same period. In a globalised and increasingly integrated world it is essential that our banking system must strictly adhere to global best practices and sound globally recognized performance benchmarks and aim at the achievement of sound financials and other soundness, strength and health indicators used at global level for performance evaluation purposes.
Triple objectives
.Banks must derive value- adding performance to fulfil the expectations of all stake holders It is also necessary to achieve Proper and smooth integration of domestic banking and financial system with global financial system. Also it is important to build up and strengthen financial infrastructure and banking system within the country. These can be considered triple objectives in the present day context . These triple objectives are sought to be achieved by means of observing universally recognized best practices.. Banks can surely show better, stronger sounder enduring and value-adding performance and undertake banking at its best in terms of quality of assets and return on assets return on equity .earnings and profitability financial strength and fundamentals ,minimization of costs ,enhancement of wealth for stake holders etc through adoption and implementation of internationally accepted best banking practices ,standards ,codes and other globally accepted performance bench marks and optimum performance indicators. Banks must give primacy to the achievement of above dual objectives.
Guided by above considerations it is absolutely essential for Indian banks to strictly adhere to global best practices and global performance benchmarks and performance indicators in different areas.
Global best practices refer to global standards bench marks and target performance levels set by international financial institutions and other organizations including Basel Committee on Banking Supervision (BCBS). These best practices have been arrived at after lot of thinking ,discussion and deliberations and based on the evaluation of the weaknesses and deficiencies which brought about financial crisis in the past. These best practices and standards cover certain relevant aspects and areas in the financial system. Their importance emanates from the fact that they contribute significantly to sound and strong financials and solid fundamentals, help strengthen financial regulation and bring about required measure of transparency, apart from contributing to the healthy development of the institution concerned..
Adoption and implementation of best practices in different areas may surely go a long way in reducing vulnerabilities of banks and financial institutions. They also provide a basis for informed decision making in different areas particularly in lending and investments. If properly used they can assist in minimizing risks of of different types... They can play an important role in bringing about uniformity and some sort of standardization of practices among all banks and financial institutions in different countries in the world. They facilitate comparative evaluation and assessment by serving as bases or bench marks with reference to which reviews and assessment can be made.
Risk Management Practices:
Risk management is by far the most important area to be covered under global best practices and standards. In the present complex environment and competitive set up the success of any financial institution depends on its risk management capabilities. Success will come only if we assess risks correctly price them properly and manage them effectively. It is always necessary to restrict or limit losses from different transactions. By means of this strategy every bank has to control and regulate its overall exposure to different areas. What banks need to-day is a strong pro-active risk management strategy which helps avoid high risks and ensures that risks are taken consciously and after perceiving all types of possibilities and with full knowledge of all facts and all aspects of the risk involved.. Basel II gives lot of importance to risk management. It is necessary for banks to clearly understand the nature of risk involved in every area of activity and in all lendings and credit exposures both fund based and non-fund based and also in investments. It is also necessary to adopt systems for measurement of performance not only in accounting terms such as return on assets (ROA) return on equity (ROE) etc, but also, for measuring the shareholder value and shareholder wealth created from time to time. It is therefore, necessary to use measures and yard sticks such as risk adjusted return on capital (RAROC) and other available measures for the purpose of assessment and evaluation..
To facilitate comprehensive evaluation and assessment banks may group or categorise customers into segments or business groups such as corporates, retail trade units ,service sector units ,housing finance companies whole sale,trading units ,manufdacturing units small business professionals and self-employed, SMEs, etc and fix a target for return or maximum return expected from each of such categories .Banks must review performance in terms of return from time to time with reference to the targets fixed for each group . If the review reveals that a particular segment or category has given a return higher than the target originally fixed for the category it is clear that that group has given something to value addition in the form of extra or excess return over the target fixed.. Capital allocation may be done having regard to what each group has given by way its contribution in relation to the target as revealed by the review. Risk adjusted performance measurement and evaluation helps in the matter of alignment of objectives at the level of each category or segment and also at the aggregate level i.e. the overall level in the bank. Adoption of such comprehensive risk management system will help banks in the process of capital allocation to different businesses and activities based on risk adjusted performance and return from each one of them. As Indian banks move progressively towards globally recognised best practices with integration of risk management in to the business process use of the yard sticks like RAOC and other measures of evaluation will greatly help in pricing decisions as well as in measurement of performance of different business segments and capital allocation to various segments and overall capital management. Consequent on the shift from capital adequacy to capital efficiency now banks have got to focus on efficient capital management capital saving and over all balance sheet management.
Best Practices for Combating Terrorism and Customer Risk Assessment
Banks have to adopt globally recognised best practices for combating terrorism and also for evaluating customer risk by adopting and implementing Anti Money Laundering Policy and programme..
. The AML policy to be adopted and implemented must match global standards. In to-day’s globalised environment organised crime groups which generate huge amounts of money through drug trafficing arms smuggling and other financial crimes may project such dirty and illegal money as legally and legitimately acquired money by means of moving the same through financial system and banking channels. Such dirty and illegal money may be transferred from one country to another for being used for terrorist activities. As a part of the global efforts at fighting money laundering and terrorist financing India has enacted Prevention of Money Laundering Act, 2002 which came into force on 1st July 2005 Recently Prevention of Money Laundering[Amendment]Bill 2008 has been adopted and this may become an Act soon. This amendment aims at checking use of illegal money for financing terror .Money changers and ,money transfer service providers are brought within ambit of this law.. India has set up Financial Intelligence Unit – India (FIU – India) in 2005. This unit collects reports regarding cash and suspicious transactions from banks and other reporting organizations analyses them and disseminates the findings and results to various law enforcement agencies for necessary action. This unit also interacts with FIUs of other countries and gathers information regarding best practices and arranges for exchange of information. Hence, every bank has to adopt a suitable AML programme and policy. Every bank must communicate to the staff at all levels the AML standards and procedures that the bank has adopted. The AML policy should also indicate the AM.L operating structure regulatory reporting and recording requirements and inspection and audit and monitoring mechanism that will be employed to ensure strict adherence to AML requirements. International standard setters such as Basel Committee and Financial Action Task Force (FATF) have done lot of work to prescribe comprehensive guidelines regarding opening of accounts, customer identification and know your customer requirements and risk management apart from customers due diligence process for financial institutions.
The Financial Action Task Force has come out with 40 recommendations which provide a comprehensive blue print for action to be taken and strategy to be adopted for preventing the use of the financial system for money laundering. Global best practices for combating money laundering require banks to develop clearly spelt out customer acceptance policies and customer identification procedure, covering description of categories of customers that are likely to pose higher than average and normal risk to banks. By adopting graduated and comprehensive customer acceptance policies and customer identification procedure banks can conduct more extensive and enhanced due diligence for customers with higher risk. The RBI has given freedom to banks to compile their own risk profiles of customers based on relevant parameters. Banks can use parameters such as geographical areas or locations, range of products and services, type of business, manner of funding the account etc for evolving its own risk profile of customers. However, risk profiling needs to be well documented so that the parameters can be well demonstrated to the regulators whenever called upon to do so.
It is necessary for banks to ensure that risk profiles are compiled and preserved for each customer at the time of commencement of relationship.
Inclusive BankingPractices
However, the customer acceptance policies must not be too restrictive resulting in denial of access to banking services to the people, particularly to the weaker and disadvantaged sections of society .Access to financial services is one of the enablers for participation in the efforts at development of the national economy. Restrictive policies may come in the way inclusive banking practices adopted by banks. Hence, adequate care has to be taken to ensure that there are no restrictive clauses in the policy resulting in denial of access to banking products and services to any category of people. Enhanced and quite extensive process of due diligence is required in the case of politicians, high net worth individuals known criminals etc and other categories of high risk customers. Developing and putting in place suitable systems of monitoring is very essential for identification of suspicious transactions throughout the period of relationship with a customer.
Reports regarding cash transactions of over Rs.10 lakhs and suspicious transactions should be generated and sent to concerned authorities. The Prevention of Money Laundering Rules 2005 have provided a definition of what constitutes suspicious activity and the procedure for reporting to the Financial Intelligence Unit (FIU) Government of India. The RBI has issued detailed guidelines to banks incorporating therein best practices in this regard and spelling out how banks have to handle the issue relating to account opening risk management reporting of cash transactions reporting of suspicious transactions to FIU (India) maintenance of records training of staff, etc. RBI has provided certain concessions and relaxations in obtaining documents by banks particularly in rural and semi urban areas. In the case of no-frills accounts KYC requirements are relaxed further to facilitate faster financial inclusion of people in rural areas.
RBI has also stressed the need for customer education regarding the importance of submission of prescribed documents at the time of opening the accounts and commencing the relationship. Banks must do their best in creating public awareness in this regard and educating the customers regarding all aspects of customer identification including submission of required documents.
Corporate Governance Practices:
Another important requirement for banks is adherence to good corporate governance philosophy and practices which must be based on an effective and independent board.. .The recent Satyam episode has shown how failure of corporate governance can cause the decline and downfall of any reputed corporate entity .The corporate governance philosophy of any organization must be based on high standard of universally accepted ethical values and disciplined approach to management .Accountability commitment ,integrity ,transparency justice .,and fairness in all activities must be hall marks of management at board level .Principles of corporate governance have now become some sort of conventional wisdom and banks have to go by this wisdom scrupulously .Corporate governance can be an effective tool for toning up the economic health and intrinsic soundness of any corporate entity .The most important objective of corporate governance is creation and enhancement of value for all stake-holders. Banks have to ensure highest ethical standards in the process of undertaking banking business activity with due diligence. Basel Committee has prescribed some important tenets and principles in this regard. These principles must be carefully adhered to .The corporate governance framework must be adequately flexible to facilitate fast response to changing market dynamics .At the same time it should be firm as regards its values and ethics The corporate governance philosophy must cover not merely regulatory ,statutory and ,legal aspects and requirements but also voluntarily accepted best practices across the world that may help attain high level of business ethics ,and maximization of value and welfare to stake holders..
The Consultative group on corporate governance headed by Dr.A.S.Ganguly has recommended that the boards must be made contemporarily professional by means of adherence to “fit and proper norms” in the matter of nomination of directors. The concerned authorities charged with the task of nominating directors must follow the fit and proper” norms and guidelines of RBI in this regard while nominating directors on the boards of banks Suitability of persons for appointment as directors must be assessed through due diligence The criteria to be followed must include qualification ,expertise track record ,integrity and other relevant fit and proper criteria.. The whole time directors must have sufficiently long period of stay as directors say three to five years to enable them to make some impact of their leadership and professional competence on the ’ performance of the bank concerned. .Directors have a responsibility to gather adequate information regarding the business and performance from time to time .Directors are expected to protect the interests of share holders .In vast majority of cases VIPs, legal luminaries and experts from different fields are inducted in to boards .Such directors must make use of their expertise and contribute significantly to the deliberations in board meetings so that sound decisions emerge on different matters at each meeting Directors must also try to provide a new perspective and new vision to board room. . VIPs and luminaries who are inducted as directors must try to create an impact instead of being directors for decorative purposes.
THRUST AREAS:
Boards of banks must concentrate on strategic planning policy formulation in respect of all vital areas such as credit ,investments ,international banking ,treasury and funds management organizational development human resources development ,issues relating to business expansion ,expansion of branch net work ,issues relating to technology. risk management systems internal control and issues concerning overall governance. These are areas of major thrust requiring prime concentration at board level.. The board must not waste time in discussing routine things and unimportant matters that can be handled at the level of bank executives..
Quality Practices- Attainment of excellence is the ultimate goal of quality practices to be adopted in any bank...
Banks must also observe best quality practices .Each bank must have a separate cell in planning department charged with the job of planning, building and institutionalizing quality across the bank .This cell can be set up in the planning department This cell can concentrate on quality improvements ,dissemination of information regarding quality creation of quality culture building up of knowledge capabilities so necessary for building up and development of quality and implementation of best quality practices .The cell must keep on studying the quality practices being pursued elsewhere and pick up and adopt the relevant and best ones in their respective institutions.
Best Compliance Practices:
Adoption of best compliance practices is another requirement of supreme importance. Compliance function in banks is an important element in the process of corporate governance and hence, there is a need to strengthen compliance management practices in all banks. According to Basel Committee on Banking supervision it is necessary for banks to have different committees such as, audit committee, management committee, risk management committee, remuneration committee, corporate governance and nomination committee, customer service committee . HR committee share transfer committee, committee for monitoring large value frauds, etc
The Audit Committee over sees reviews and provides directions to the internal audit/inspection function in the Bank in order to ensure and enhance effectiveness of audit and inspection functions as strong management tools The Audit Committee must focus on investment portfolio including debt and shares held with a view to finding out deterioration in value if any.. The committee also reviews all the issues raised in the Long Form Audit Reports. It also interacts with external auditors before finalization of Audited Accounts Management committee has the responsibility taking decisions on high value credit compromise and write off proposals etc Risk management committee identifies evaluates monitors and guides the Bank on various categories of risks to which bank is exposed and devices suitable strategies for managing credit market liquidity operational and legal compliance and reputation and other risks of the bank. Remuneration committee is charged with the job of providing oversight of remuneration of top and senior management and other key personnel performance linked incentives etc and ensuring that compensation is consistent with banks objectives, strategy culture and control environment. Nomination committee has to provide evaluation of effectiveness of board. It undertakes the process of due diligence for determining fit and proper status of existing elected directors and persons to be elected as directors compliance function is a vital function and forms part and parcel of governance in banks.
In the case of listed banks capital market related regulatory compliance must also be ensured. Other committees perform the functions relevant to them. The compliance function should ensure that existing prescribed procedures, guidelines system and controls capture the required information and data in order to facilitate discharge of risk management function at the board level. Compliance must start at the top. Compliance can be effective in a corporate culture where board assumes full responsibility for compliance. Bank Boards must ensure that a proper compliance policy is put in place and board should also oversee its implementation. A robust compliance system should be put in place along with a comprehensive compliance policy. Compliance policy must cover compliance philosophy of the bank role of chief compliance officer and compliance department and composition of its staff and their specific responsibilities. The Board may review the policy from time to time. The Board must also review compliance periodically. Bank boards may constitute compliance committee to oversee the compliance of all regulatory and reporting requirements as well as with banking laws, taxation laws, international laws, labour laws, accounting standards, anti-money laundering Act, fiscal Responsibility Act Right to Information Act and so on. Non-compliance of any of the laws will entail financial and reputation risk to the Bank.
Transparency Practices
The next important requirement is transparency and disclosure in financial statements. The data and details given in financial statements must be adequate to ensure adequate measure of transparency. This enables the public at large and customers to evaluate financial position and performance of the bank. The disclosures are useful to the public in assessing and understanding where exactly the bank stands in relation to their expectations and in in making decisions regarding choice of banks for keeping their deposits and also for other banking needs. The users of financial statements are interested in the liquidity and solvency and risk in respect of assets and liabilities figuring in and recognised on the Balance sheet of the bank and also off balance sheet items of the bank.. Banks may do well to explain the way they manage and control risks associated with the operations of the bank. Banks may provide commentary and notes on the financial statements for clarity of understanding. The generally accepted accounting principles and standards must be followed. The Auditing and Assurance Standards Board of the Institute of Chartered Accountants of India has issued as many as 35 standards which must be followed.
The next vital requirements is assessment of position with reference to Industry best practices. Assessment of best practices involves analysis of the organisation’s processes, work flow planning process and strategic planning staffing, major areas such as retail delivery sales CRM strategy and CRM operations human resources finance and funds management investments management and accounting. The objective of this assessment is to reduce current operating expenses, improve productivity to avoid future cost increases, increase returns and revenue, improve quality of service delivery and position the bank for continued growth and expansion. Best practices provide bench mark for market participants to operate efficiently. But, their implementation must be suitable to country specific priorities and circumstances.
As rightly stated by Dr Y V Reddy, Past Governor of RBI, “the implementation of standards must fit into a country’s overall strategy for economic and financial sector development taking into account the stage of development, level of institutional capacity and other domestic factors”. The Standing Committee on International Financial Standards and Codes monitors developments in global standards and codes and looks into applicability of these standards to Indian Financial System. The approach of RBI to the adoption and internalisation of global best practices prudential norms and standards and codes in respect of Indian banks is one of slow,steady and gradual shift and convergence with international standards and best practices with apposite and required changes so as to make them relevant to banks in India..
PRACTICE OF DHARMA and Fair Practices.-
All activities ,operations and over all governance must be guided by dharma and tenets of dharma. .Banks must follow the fair practices contained in the code of commitment to customers .The objective of the code is to promote good and fair practices by setting minimum standards in dealing with customers and to provide full information to customers regarding products and ,services so as to enable them to take informed decisions .Enhancement of transparency ,to encourage market forces through competition ,to achieve high operating standards to promote fair and cordial relationship between the bank and customers and to foster confidence in the bank concerned and the banking system in general are other objectives of the code.
The code must apply to all products and services offered by banks .Products and services offered by banks must conform to relevant laws and rules as well as regulations .The dealings of banks with customers must rest on ethical principles of integrity ,and transparency .Banks must help customers by providing regular updates and by keeping them informed about changes in interest rates ,charges or terms and conditions .Banks must rectify mistakes in rates applied or in other calculations promptly and reverse charges applied by mistake if any promptly .Also banks must attend to customer complaints speedily and redress them expeditiously .Banks must practice non-discrimination policy .There must be no discrimination on the basis of religion ,caste creed ,race sex physical disability etc Full transparency regarding rates of interest processing charge and other charges etc must be ensured .Changes in rates of interest and fees payable must be communicated to parties concerned by display of suitable notice on notice board ,or some other means of communication .All advertisements and publicity material must be clear and there must be no ambiguity .All personal information regarding customers must be treated as private and confidential even after cessation of relationship except in cases where information has to be given as per law or by way of duty towards public and in public interest .While granting loans banks must explain repayment process by way of amount ,tenure ,periodicity of payment preclosure penalty if any and representatives authorized to collect repayments must adhere to prescribed guidelines .Privacy of customers must be respected .Interaction with customers must be in very civil manner .During recovery visits decency and decorum must be maintained .Customers must be contacted ordinarily at the place of his or her choice and in the absence of specified place at residence and if unavailable at residence at the place of business .Identity and authority of the person to represent the bank must be made known to the customer .Thus all the fair practices contained in the code must be adhered to by banks .By adhering to code of commitment ,fair practices and tenets of dharma banks can enhance their public image and win customer loyalty and customer commitment which will go a long way in helping banks in business expansion and business performance.
Practice of Adhering to Globally Recognised Performance Indicators and Bench Marks.
It is also necessary for banks to try to achieve global bench marks in diverse areas such as capital adequacy ratio return on assets, net interest margin cost income ratio non-performing loans ratio, provisioning of non-performing loans ratio, capital asset ratio, funding volatility ratio, etc. Banks must on an on-going basis review their performance in attaining the highest ratios with reference to the ratios obtaining in other countries and also with reference to the globally accepted best ratios.
Each bank must institute a system of review of their performance in these areas with reference to the highest ratios in these areas achieved by banks in India as well as other developed countries and also with reference to the overall global position. On the basis of reviews from time to time banks must initiate necessary measures to improve the performance in the areas where performance is found inadequate in relation to global ratios performance indicators and bench marks. These reviews must be made at the highest level in management including the board level.
Simultaneous Achievement:
Indian banks must continue to perform well and continue to give excellent financial results while simultaneously contributing substantially by way of value to stake holders. At the same time, they have to discharge the social obligations cast upon them and fulfil the expectations of society. All these can be simultaneously achieved only by means of strict adherence to global best practices, global standards and codes and global bench marks and other performance and soundness indicators explained earlier. Best practices may keep on changing and evolving over time across the world and banks must be constantly alive to the changes and developments in this regard from time to time. It will always be prudent for banks to adopt a pro-active approach in the matter of adoption of best practices. Each bank may create a global best practices cell in the corporate office for the purpose of studying the developments and evolution of best practices elsewhere for the purpose of facilitating adoption of a pro-active approach apart from implementing the guidelines ,and directions issued from time to time by RBI regarding best practices to be observed.
The above cell can be charged with the job of studying the domestic developments as well as developments across the world in the area of best practices. It should also evaluate the performance of the bank in achieving global bench marks in different areas and other performance and soundness indicators with reference to the attainments in the concerned areas in other advanced countries and at global level and place the results and findings of the review before the top management and the Board of directors. Based on such reviews banks can take required steps for fine tuning the implementation of best practices, strategies, processes and other aspects of functioning with a view to achieving better operational and financial results and higher value for stakeholders. Banks have thus got to aim at banking at its best in terms of quality of service to customers ,maximization of earnings ,and profits and creation and enhancement and maximization of value for the stake holders minimization of risks to the lowest level possible implementation of norms standards ,and regulatory requirements to the satisfaction of regulators fulfillment of social objectives and fulfillment of the expectations of society. All these can be achieved only by means of strict adherence to and observance of best practices.
Subscribe to:
Posts (Atom)