Financial regulation and supervision are the two important functions of the RBI. Though the RBI is known for its function of monetary policy implementation, financial regulation and supervision are more effort taking as well as sophisticated functions. Supervision helps the RBI to continuously check to assess the health and stability of the financial system. Without effective supervision, the financial system may face crisis.
Regulation is just stipulating rules in accordance with the laws framed by the government for the effective control over the financial system. There is the Banking Regulation Act to regulate banks.
Supervision is different from regulation. Here, the RBI goes to the headquarter of the bank to check whether the bank’s balance sheet is good. Objective of supervision is to ensure that banks remains healthy and stable.
Several norms are there for effective supervision. Supervision requires onsite surveillance of banks. Since the RBI is the regulator for most of the money market institutions including banks and Non-Banking Financial Institutions, there need a separate entity. The RBI has constituted a separate unit for supervision and it is called Board for Financial Supervision (BFS). The convention in central banking is that regulation and supervision should not be done by the same entity.
Board for Financial Supervision
The Board for Financial Supervision (BFS) was constituted in November 1994 to supervise the money market institutions in the country. The BFS has been constituted as an autonomous body under the RBI.
Board is drawn from the members of the Central Board of the Reserve Bank with the Governor as Chairman and one of the Deputy Governors as full time Vice-Chairman. The Board exercises the powers of supervision and inspection under the RBI Act, 1934 and the Banking Regulation Act, 1949 in relation to the different sectors of the financial system.
The BFS was initially given the mandate for supervision of commercial banks, Financial Institutions and NBFCs. Later, urban cooperative banks and primary dealers were also brought under the purview of the BFS. Since its formation, the BFS which meets every month, conducting on-site supervision of banks and off-site monitoring, based on quarterly reporting system.
Banking Supervision procedure
The main instrument of supervision in India is the periodical on-site inspection of banks that is supplemented by off-site monitoring and surveillance. Since 1995, on-site inspections are based on CAMELS (Capital adequacy, asset quality, management, earning, liquidity and systems and controls) model and aim at achieving the set objectives.
The domestic banks are rated on CAMELS model while foreign banks are rated on CALCS model (capital adequacy, assets quality, liquidity, compliance and systems). The frequency of inspections is generally annual, which can be increased / reduced depending on the financial position, methods of operation and compliance record of the bank.