By Anthony Harrington
In August 2013, the International Monetary Fund (IMF) published its Detailed Assessment Report [pdf] on the Indian financial sector's compliance with the core Basel principles. The report itself was based on a detailed fact finding and assessment mission by the IMF in 2011 and 2012. It gave India an A+ for running a tight ship with respect to its higher than minimum capital requirements; frequent hands-on and comprehensive onsite inspections; and conservative liquidity risk policy. The IMF also praised the restrictions that the Reserve Bank of India (RBI) has placed on the capacity of Indian banks to take on more volatile exposures, and commended the fact that the Indian banking system remained relatively stable through the global financial crash of 2008.
However, it was less than happy with the fact that the RBI remains tied in part to the Indian government and is not independent. This, the IMF suggests, puts the RBI in a peculiar position when it is auditing state banks. In a properly organised set up the auditor should be independent of the client, for obvious reasons. A government owned bank auditing government banks is not ideal. In its press release response to the IMF's report, the RBI said, more or less politely, that the IMF was barking up the wrong tree. The RBI may not have de jure independence, but it is de facto independent, it said, and the IMF conceded that there were no instances of de facto government interference in the affairs of the RBI or any government hindrance of the RBI's supervisory function.
The IMF was also bothered by the fact that Indian banks operate in some 45 overseas jurisdictions, including in unstable areas where, as the IMF puts it, "it cannot be assumed that strong supervisory practices are in place." The RBI, it said, has only signed Memoranda of Understanding (MoUs) with two jurisdictions, so there is a significant informational gap. Moreover, the RBI had not carried out any overseas inspections of Indian banks since 2008. Some of the host countries also seemed to have lax or dodgy internal licensing and/or supervisory practices, all of which could enable a bank to go badly wrong. One is tempted here to point out that being in a well regulated developed market with all the supervisory paraphernalia didn't prevent HSBC from having some of its operations involved in egregious money laundering, but one gets the point. Way too many opportunities exist for Indian banks to drift into poor or outright dodgy practices when they run overseas operations that are hardly ever subject to proper supervisory scrutiny.
The RBI's response was, again, robust. Since the IMF's assessment in January 2013, it pointed out, significant progress has been made. The RBI has entered into MoUs on "Supervisory Co-operation and Exchange of Information" with 16 overseas jurisdictions and is in correspondence with another 28 jurisdictions to finalize mutually acceptable MoUs. Moreover in 2012 it carried out overseas inspections of five Indian banks in foreign jurisdictions, with a total value of some 60% of Indian overseas assets. Indian banks in a further six overseas jurisdictions currently have ongoing inspections, which brings another 20% of India's overseas assets within the inspection purview of the RBI. It points out too that the Indian Financial Sector Legislative Reforms Commission has itself made recommendations to streamline and further strengthen the statutory framework and to address regulatory overlaps.
There were other criticisms that the IMF raised, including the fact that, at the time it did its assessment, the RBI was not empowered to inspect associate companies of Indian banks or financial conglomerates. However the RBI points out that thanks to a December 2012 amendment to Section 29A of the Banking Regulation Act, the RBI has the power to inspect any associate enterprise of a banking company.
Read together, the IMF assessment and the RBI response show that the Indian banking and financial system is in very reasonable health. This is probably more than can be said for the Indian economy as a whole, which is struggling with some fairly intractable problems - not least, securing sufficient electrical power for its industries, never mind bringing the benefits of electrification to more rural areas.