BANGLADESH BANKS SUPERVISION ON BANKING SECTOR

Background
The health of the economy and the effectiveness of monetary policy depend on a sound financial system. Through supervising and regulating financial institutions, central bank is better able to make policy decisions. Bank supervision involves monitoring and examining the condition of banks and their compliance with laws and regulations. If a bank under the central banks jurisdiction is found to have problems or be noncompliant, the central bank may use its authority to request that the bank correct the problems. Bank regulation includes issuing specific regulations and guidelines to govern the operations, activities and acquisitions of banking organizations. Central bank supervises and regulates a wide range of financial institutions and activities. In Bangladesh the Bangladesh Bank works in conjunction with other national and countrys authorities to ensure that financial institutions safely manage their operations and provide fair and equitable services to consumers. Bank examiners also gather information on trends in the financial industry, which helps the Bangladesh Bank meet its other responsibilities, including determining monetary policy. Bangladesh Bank was created under the Presidents Order no.127 of 1972 with effect from 16th December, 1971. As we the people from least developed country our central bank has some developing function along with its statutory function. The core legal framework for banking supervision in Bangladesh is laid down in article 7A (f), the Bangladesh Bank Order, 1972 and in section 44 of the Bank Company Act, 1991(BCA).

Why central bank supervise bank?

Two major focuses of banking supervision and regulation are the safety and soundness of financial institutions and compliance with consumer protection laws. To measure the safety and soundness of a bank, an examiner performs an on-site examination review of the bank's performance based on its management and financial condition, and its compliance with regulations.

Objectives of Inspection/Supervision:
a. Asses the financial soundness bank and financial institutions b. Dig out procedural defects/lapses/deficiencies and functional irregularities and to incorporate the same in the inspection reports c. Bring out the various irregularities incorporated and recommendations made in the report to the notice of the top management of the organization concerned in order to put it on sound footing, and d. Develop sound banking practice in Bangladesh.

Two way of supervision:

The process of bank supervision takes two forms. One is the regulatory or off-site monitoring process, while the other is on-site inspection or bank examination process. Bank regulation usually deals with the formulation and implementation of specific rules and regulations for the conduct of banking business, including the monitoring of the compliance with such rules. On the other hand, on side inspection, ensure compliance with the rules and regulations and asses the soundness of individual institutions.

Some of the key areas of inspection are:

1. 2. 3. 4. 5. 6. 7. 8. 9. Evaluating of assets with emphasis on classification & provisioning Assessing capital position to work out required capital Verification of artificial manipulation of figures relating to profit Review of liquidity position so that required amount of CRR & SLR is maintained Evaluation of loan operation, project financing, and other off balance sheet activities Analysis of large loans and concentration of credit Incidence of fraud, forgery, and action there of Evaluation of management quality as well as customer services at the branch level Compliance of various circulars issued by BB as well as respective banks.

Inspection lay down in certain statutes:

- Bangladesh Bank Order, 1972 - Bank Company Act, 1991 - Foreign Exchange Regulations Act, 1947 - Financial Institutions Act, 1993 - Financial Institutions Regulations, 1994 - Co-operative Society Ordinance, 1984

Provisions under which Bangladesh Bank conducts inspections:

Provisions (a)Under section 44(i) of the Bank Company Act-1991 Institutions subject to inspections Scheduled Banks and all branches Investment Corporation of Bangladesh Grameen Bank Ansar VDP Bank Ltd.

(b) Under Article 55 of the Bangladesh Bank Scheduled Banks, all branches of Scheduled Banks & other Order, 1972 financial institutions (c) Under section 19A of the Foreign Exchange RegulationsAct-1947 (d) Under 82(i) (B) of the Co-operative societies Ordinance-1984 (e) Under Article 3 of the Bank Company Act-1991 (CCLMBL) (f) Under section 5 and 20 of the Financial Institutions Act-1993 and the Financial Institution Regulations-1994 Others viz. Aziz Co-operative Bank Ltd. etc. Financial Institutions Industrial Dev. Leasing Company (IDLC) United Leasing Company (UIC) UAE Bangladesh Investment Co. Ltd. (BICL) International Department (ID) Authorized dealer branches International hotels Indenting firms Money Changers Air lines General sales agent etc. Thana Central Co-operative Association (TCCA) Sugarcane Growers Co-operative Societies (SGCS) Bangladesh Samabaya Bank Ltd, (BSBL) Central Co-operative Bank Ltd. (CCBL) Central Co-operative Land Mortgage Bank Ltd.

This department is also performs the following functions: 1. Asses the overall credit and liquidity position of the banking system 2. Approves large loans extended by the scheduled banks. 3. Monitors maintenance of reserve requirement by scheduled banks. 4. Review approval procedures and techniques followed by the scheduled banks in approving loans amounting to taka. 10 million and above to ensure proper compliance of standard practices. 5. Monitors capital adequacy of the scheduled banks, position of non performing assets and performance of top 20 defaulters. 7. Maintains accounts of the liquidated banks and deals with the movable and immovable properties of the liquated banks as liquidator. 3

8. Prepare and submits quarterly memorandum detailing financial conditions of the nationalized commercial banks to the board of directors of Bangladesh bank.

Banking Supervision by Basel Committee:

The Basel Committee on Banking Supervision (BCBS) is a committee of banking supervisory authorities that was established by the central bank governors of the Group of Ten countries in 1974. It provides a forum for regular cooperation on banking supervisory matters. Its objective is to enhance understanding of key supervisory issues and improve the quality of banking supervision worldwide. The Committee also frames guidelines and standards in different areas - some of the better known among them are the international standards on capital adequacy, the Core Principles for Effective Banking Supervision and the Concordat on cross-border banking supervision. The Committee's members come from Argentina, Australia, Belgium, Brazil, Canada, China, France, Germany, Hong Kong SAR, India, Indonesia, Italy, Japan, Korea, Luxembourg, Mexico, the Netherlands, Russia, Saudi Arabia, Singapore, South Africa, Spain, Sweden, Switzerland, Turkey, the United Kingdom and the United States. The Committee's Secretariat is located at the Bank for International Settlements (BIS) in Basel, Switzerland. However, the BIS and the Basel Committee remain two distinct entities. The Basel Committee formulates broad supervisory standards and guidelines and recommends statements of best practice in banking supervision (see bank regulation or "Basel III Accord", for example) in the expectation that member authorities and other nations' authorities will take steps to implement them through their own national systems, whether in statutory form or otherwise. The purpose of BCBS is to encourage convergence toward common approaches and standards. The Committee is not a classical multilateral organization, in part because it has no founding treaty. BCBS does not issue binding regulation; rather, it functions as an informal forum in which policy solutions and standards are developed. The Committee is further sub-divided each of which have specific task forces to work on specific implementation issues: The Standards Implementation Group (SIG) o Operational Risk Subgroup - addresses issues related to Advanced Measurement Approach for Operational Risk o Task Force on Colleges - develops guidance on the Basel Committee's work on supervisory colleges o Task Force on Renumeration - promotes the adoption of sound renumeration practices o Standards Monitoring Procedures Task Force - develops procedures to achieve greater effectiveness and consistency in standards monitoring and implementation The Policy Development Group (PDG) o Risk Management and Modelling Group - point of contact with the industry on the latest advances in risk measurement and management o Research Task Force - facilitates economists from member institutions to discuss research on financial stability in consultation with the academic sector 4

o Trading Book Group - reviews how risks in the trading book should be captured by regulatory capital o Working Group on Liquidity - works on global standards for liquidity risk management and regulation o Definition of Capital Subgroup - reviews eligible capital instruments o Capital Monitoring Group - co-ordinates the expertise of national supervisor in monitoring capital requirements o Cross-border Bank Resolution Group - compares the national policies, legal frameworks and the allocation of responsibilities for the resolution of banks with significant cross-border operations The Accounting Task Force (ATF) - ensures that accounting and auditing standards help promote sound risk management thereby maintaining the safety and soundness of the banking system o Audit subgroup - explores key audit issues and co-ordinates with other bodies to promote standards The Basel Consultative Group (BCG) - facilitates engagement between banking supervisors including dialogue with non-member countries The Basel committee along with its sister organizations, the International Organization of Securities Commissions and International Association of Insurance Supervisors together make up the Joint Forum of international financial regulators.

Supervision of Banks in Bangladesh

Various principles of Basle Agreement are being followed in Bangladesh: 1. Precondition of Effective Banking Supervision (Principle 1) 2. Licensing and Structure (Principle 2-5) 3. Prudential Regulations and Requirements (Principle 6-15) 4. Methods of Ongoing Banking Supervision ( Principles 16-19) 5. Information requirement of Banking companies (Principal 21-22) With a view to promoting and maintaining soundness, solvency and systematic stability of the financial sector as well as to protecting interest of depositors, BB carries out two types of supervision namely (i) off-site supervision and (ii) on-site supervision.

Off site supervision (DOS)

In most countries, the role of off-site bank supervision involves continuous monitoring of profitability, risk and capital adequacy. In Bangladesh Bank, Banking Regulation and Policy Department (BRPD), Department of Off-site Supervision (DOS) carries out off-site supervision functions. This department supervises and monitors the functions of the schedule banks in Bangladesh through off site surveillance. Through off site supervision the bank continuously analyses the overall position particularly financial condition of the scheduled banks on the basis of five crucial indicators of banking operation, capital adequacy, asset quality, management efficiency, earning power and liquidity position. Ratings are done on a scale of 1 to 5 in ascending order of performance deficiency. A bank is identified as problem bank if it has a CAMEL composite score of 4 or 5. Such problem banks are then brought under the fold of problem bank monitoring department for closer and more intensive supervision. CAMELS The examiner uses the CAMELS rating system to help measure the safety and soundness of a bank. Each letter stands for one of the six components of a banks condition: capital adequacy, asset quality, management, earnings, liquidity and sensitivity to market risk. When performing an examination to determine a banks CAMELS rating, instead of reviewing every detail, the examiner evaluates the overall health of the bank and the ability of the bank to manage risk. A simple definition of risk is the banks ability to collect from borrowers and meet the claims of its depositors. A bank that successfully manages risk has clear and concise written policies. It also has internal controls, such as separation of duties. For example, a banks management will assign one person to make loans and another person to collect loan payments. 5-Cs A safety and soundness examiner also reviews a banks lending activity by rating the quality of a sample of loans made by the bank. When a bank reviews a loan application, it uses the "5-Cs" to assess the quality of the applicant. The 5-Cs stand for:

Capacity - measures the borrowers ability to pay, including borrowers payment source and amount of income relative to debt. Collateral - what are the banks options if the loan is not paid? What asset can be turned over to the bank, what is its market value, and can it be sold easily? A valuable asset might be a house or a car. Condition - this refers to the borrowers circumstances. For example, if a furniture storeowner is asking for a loan, the banker would be interested in how many chairs and sofas the store is expected to sell in the area over the next five years. Capital - the applicants assets (house, car, savings) minus liabilities (home mortgage, credit card balance) represent capital. If liabilities outweigh assets, the borrower might have difficulty repaying a loan if his regular source of income unexpectedly decreases.

Character - measures the borrowers willingness to pay, including the borrowers payment history, credit report and information from other lenders. (Federal reserve education)

On-site Inspection of Banks

As part of Bank's statutory function, currently five departments of BB namely a. Department of Banking Inspection-1 (DBI-1), b. Department of Banking Inspection-2 (DBI-2), c. Department of Banking Inspection-3 (DBI-3), d. Foreign Exchange Inspection and Vigilance Department (FEIVD) and e. Anti-Money Laundering Department (AMLD) are conducting the inspection activities. These five departments conduct on-site inspection on SCBs, DFIs, PCBs (including banks under Islamic Shariah), FCBs and other institutions including Investment Corporation of Bangladesh (ICB) and Money Changers. Organ gram of Bank Supervision Departments (assignment.com)

The broad objectives of on-site inspection are as follows:

To promote soundness, solvency and systemic stability of the financial sector as well as to protect depositors' interests, To ensure safety, stability and discipline in the banking sector; To ensure compliance of banking laws, rules and regulations; To combat money laundering and terrorist financing activities, To evaluate quality and performance of bank management and Board of Directors, To identify weaknesses which are to be addressed to strengthen the banks, and To evaluate financial soundness and operational efficiency of the banks. Basically, three types of inspections are conducted namely a. comprehensive inspection, b. risk based inspection/system check inspection, and c. special inspection. In comprehensive inspection, overall performance/conditions of the banks such as capital adequacy, asset quality, liquidity, earnings, management competence etc. are evaluated. Based on their performance banks are rated between 1-5 grades in ascending order. Inspection is done according to the Annual Inspection Programme chalked out by the respective departments well ahead of the beginning of each calendar year. The on-site Inspection Departments also monitor implementation of the suggestions or recommendations made in the inspection reports. Risk based inspection is conducted to examine the compliance of the Core Risk Management Guidelines issued by BB as well as to evaluate and monitor risk management systems and control environment of the banks. The frequency of the inspection is annual and areas covered are risks associated with credit, internal control and compliance, asset liability management and information system. Special inspections are conducted on the banks on specific/particular issue(s) as well as to investigate complaints received from the depositors, general public or institutions.

Time schedule of Inspection

Commercial Banks having CAMELS rating between 3-5 are inspected every year. Banks rated 1 or 2 are inspected once in every two years. Branches of scheduled banks covering around 60-70 percent of total loans and advances are normally brought under the comprehensive inspection programme.

Inspections of the banks are conducted based on four reference dates: 31 December, 31 March, 30 June and 30 September instead of only one reference date i.e. 31 December. This system has been adopted to enhance the effectiveness of onsite inspection and to reduce the time gap between on-site and off-site supervision.

Bangladesh Bank Inspection Result 2010-2011

In FY11, DBI-1 conducted a total of 725 comprehensive inspections including 35 Head Offices and 690 branches, core risk inspections on 39 banks and special inspection on 134 bank branches. DBI-2 conducted a total of 1149 comprehensive inspection including 5 Head Offices and 1149 bank branches. The Department also conducted 76 comprehensive inspections on financial institutions (FIs) including 24 head offices & 52 branches and 10 inspections on ICB including its head office and 9 branches. Besides, the Department conducted 22 riskbased inspections on banks. Moreover, the Department also conducted 224 special inspections on banks, 8 special inspections on FIs and 1 on ICB. DBI-3 conducted a total of 445 comprehensive inspections on banks including 5 head offices and 440 branches. The Department conducted 4 risk based and 40 special inspections on banks. FEIVD conducts inspection on foreign trade financing, treasury functions and foreign exchange risk management of banks, foreign exchange transactions of banks and money changers. In FY11, the Department conducted a total of 251 comprehensive inspections on banks including 45 head offices and 206 authorised dealer branches. The Department also conducted 393 special inspections on various banking irregularities, 46 special inspections on foreign exchange risk management and 380 inspections on money changers. In FY11, AMLD conducted system check inspection in 47 head offices and 365 bank branches under core risk programme. The Department also conducted special inspection on 131 branches and head offices of 10 banks. In the reporting year, 5 banks have been fined for non-compliance of the Money Laundering Prevention Act, 2009.

Conclusion
In the light of discussion we can proclaim that the supervision of Bangladesh Bank is significantly meaningful; though, it cannot be claimed as up to the mark. Many improvements are yet to be made and some steps should be taken. For this purpose some recommendations are put forward: Presently Bangladesh bank is not enjoying the autonomy to its full extent. It is very much essential for a central bank to regulate the scheduled banks stringently. Strict enforcement of policies should be made by the central bank to ensure that no banks, especially public commercial banks, relax credit standards on insider loans and make such loans on preferential terms. Risk Based Supervision (RBS) is getting priority in developed countries for its logical superiority. Bangladesh bank should try to adopt this system of bank supervision as its main supervisory weapon. Bangladesh Banks supervision departments are required to take steps for strengthening the onsite inspection as banks network are ever increasing. As present banking laws is ineffective and loan defaulters are taking full advantage of this weakness, it is crying need to make suitable amendments to the Artho Rin Adalot Ain 2003. As foreign exchange transaction has increased manifold, proper amendment in the Foreign Exchange Regulation Act, 1947 is needed.

References:
http:www.bis.org: Core principal for effective Banking Supervision , Basle Committee on Banking Supervision, September. 1997. http://www.federalreserveeducation.org/about-the-fed/structure-and-functions/bankingsupervision/ http://en.wikipedia.org/wiki/Basel_Committee_on_Banking_Supervision http:www.bb.org.bd

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www.assignmentpoint.com Bangladesh Bank, Annual Report (2010-2011).

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