Introduction

While regulations provide the policy framework to ensure solvency and liquidity of banks and financial institutions (FIs), supervision refers to the instruments used to ensure compliance to this framework. Internationally, different models are followed in the performance of these two functions. In some countries, the two functions are entrusted to different agencies. In the Reserve Bank, the two functions were kept apart in respect of commercial banks, and these were handled by two different departments. However, in respect of non-banking financial companies (NBFCs), FIs and urban cooperative banks (UCBs), there was one department/division each responsible for both regulation and supervision during the reference period. The National Bank for Agriculture and Rural Development (NABARD) exercised supervisory powers over regional rural banks (RRBs) and banks in the rural cooperative structure.

As the previous chapters have shown, major changes happened in the Indian financial sector during the period covered in this volume. These changes offered consumers a broader range of products, complex and new business processes, and a reformed financial system. The changes also led to a blurring of the distinction between banking and non-banking businesses. Supervision, as this chapter shows, needed to adapt to these changes.

The chapter discusses the supervisory role of the Bank in four segments: commercial banks, NBFCs, UCBs and FIs. It also discusses how important episodes involving individual banks and institutions under stress led to changes in supervisory practices and policies.

Supervision of Commercial Banks

The Framework of Supervision

While conventionally the Reserve Bank relied on periodic on-site inspection of banks as the main instrument of supervision, the system was modified from time to time. In December 1993, the Bank bifurcated the regulatory and supervisory functions by entrusting the supervisory function to a newly created Department of Supervision. The setting up of the Board for Financial Supervision (BFS) in November 1994 was a milestone. The jurisdiction of the BFS, which originally covered commercial banks, was extended to FIs, NBFCs, UCBs, local area banks and primary dealers (PDs). The BFS laid down broad policies for on-site supervision and off-site monitoring, modalities for follow-up of inspection reports, and correction strategies for weaknesses observed in the functioning of banks and FIs.