Compliance function

General Banking and Compliance
Function

Atul Kela

 Banking Industry in India is highly regulated and is governed by various
regulations. Indian banks, the dominant financial intermediaries have to abide
by these regulations

 The Business Compliance functions play a key role in maintaining and
improving the corporate governance standards within the Bank

 To fulfill the core values of the Bank within the regulatory ambit, a detailed
understanding of the „General Banking and Compliance Function‟ is essential.

 The training therefore shall help the participants in a two pronged way as under:
 Get insights into the regulations functioning and various practices that are
central and specific to banking.
 Optimally utilize the training experience for implementing the same in their
respective business areas.

Management Perspective

 Human capital is increasingly regarded as one of the major drivers
of productivity, economic growth and competitive advantage.

 In the increased competitive scenario and complexity of Banking
functions, developing the human resource has become of key
ingredient for survival of Bank.

 A learned employee can retain customers and increase business &
market share through proper behavior and good public relations

Attitude towards training

 How is that related to what I do?
 “I‟m good at my job and anyway, I have no
time”
 “I suppose that‟s my weekends shot for
months!”

Why training?

The sharing of information through training is our
most valuable tool to develop our most valuable
asset…

Employees

How do Employees Learn the Best?

“Tell me and I forget, teach me and I
remember, involve me and I learn”

- Benjamin Franklin

Objective of this training
 Overview of Banking in India
 Types of Banking Institutions
 Key characteristic of different Banking institutions

 General Banking
 Definition of Banking and Banking Company
 Understanding of accounting framework of Banks
 Banking terminologies

 Regulatory Framework
 Principal enactments
 Important Regulatory guidelines

 Compliance Function
 Significance of Compliance function
 Compliance process and procedure

Overview of Banking in India
There are four types of Banking institutions in India:
 Regional rural banks
 Co-operative banks
 Development banks (more commonly known as „term lending
institutions)
 Commercial banks

Overview of Banking in India (contd)

Key characteristic of Banking institutions
Type of Bank Characteristic
Regional Rural Bank They are formed for specifically lending to business like
farmers, agricultural marketing societies, co-operative
farming societies, small entrepreneurs, etc. Each RRB has a
public sector bank as its ‘sponsor bank’. Capital in each bank
is contributed by the Central government , the sponsor bank
and state government in proportion of 50, 35 and 15
percent respectively.
Co-operative bank These are banks in co-operative sector which cater primarily
to the credit needs of the farming and allied sectors. Co-
operative banks include central, state , primary (Urban) co-
operative banks. They operate within a specific geographic
jurisdiction as determined by its bye – laws. They lend
money only to its members or to registered societies
Development Bank These banks were started with objective of providing only
long term finance for development purpose.

Overview of Banking in India (contd)
Commercial banks can be divided into types based on their ownership

 Public Sector banks
Comprises State Bank of India, its Seven Subsidiaries and nationalised banks.
Majority of Stake in State bank of India is of Government of India

 Private Sector banks
Ownership is in private hands. They are three types:
 Indian Scheduled Commercial bank other than public sector banks (Scheduled
Commercial bank means banks included in Second Schedule to the Reserve
Bank of India Act 1934)
 Non - scheduled banks
 Indian branches on banks incorporated outside India, commonly referred to as
„foreign banks‟.

General Banking
Definition of Banking
Banking means the accepting, for the purpose of lending or investment, of
deposits of money from the public, repayable on demand or otherwise, and
withdrawal by cheque, draft, or otherwise;
(Section 5(b) of Banking Regulation Act, 1949)

Definition of Banking Company
Banking Company means company which transacts the business of banking in
India.
(Section 5(c) of Banking Regulation Act, 1949)

Two Essential Criteria:
1) Accepting deposits of money from public
2) For purpose of Lending or investment

General Banking (contd)
Other forms of business by banking company

In addition to the business of banking, banking company may engage in any one
or more of the forms of business prescribed in Section 6 sub section (1) of
Banking Regulation Act, 1949

Section 6 sub section (2) of Banking Regulation Act, 1949 prohibits a banking
company to engage in any form of business other than those referred to in
Section 6 sub section (1)

Other forms of business includes discounting bills of exchange, issuing letter of
credit, travellers cheque, buying and selling of foreign exchange, acting as agent
for government authority etc.

Accounting framework
Sources of Funds Cost
 Deposits from Public  Interest Payable (Expense)

 Borrowings from Other  Interest Payable (Expense)
financial institutions / RBI
 Dividend Paid (Appropriation of Net
 Capital (Owner)
Income)

Application of Funds Income
 Lending (Advances)  Interest Receivable and Fee (Income)
 Investments  Dividend / Interest Receivable (Income)

 Deposits with other
 Interest Receivable (Income)
financial institutions / RBI

 Fixed Assets  Depreciation (Non cash expenses – utilized for
creation of fixed asset in future)

Accounting framework (contd)

Cost / Expenditure
 Interest Expense (on Deposits and Borrowings)
 Operating Expenses
 Employee Salaries
 Rent
 Printing and Stationery
 Administrative expenses
 Other Expenses (Directors fees, auditors fees etc)

Income
 Interest and Divided Income (on Advances and Investments)
 Other Income
 Commission and brokerage
 Profit on sale of investments & fixed assets
 Profit on foreign exchange transactions
 Miscellaneous income

Accounting framework (contd)
 Provisions and Contingencies
 Provision on Assets (Standard Assets, Non performing Assets,
restructured assets)
 Provision for tax (Income tax, wealth tax, fringe benefit tax)
 Other provision and contingencies

 Surplus (Income minus Cost minus Provisions and contingencies)
Appropriated
 Statutory reserves
 Dividend to Shareholders
 Balance if any is transferred to Reserves

Banking Terminology

Key Rates Brief Description
Repo Rate It is the rate at which banks borrow money from the RBI
for short period by selling their securities (financial
assets) to the central bank with an agreement to
repurchase it at a future date at predetermined price.

Reverse Repo Rate It is the rate of interest at which the RBI borrows funds
from other banks for a short duration. The banks deposit
their short term excess funds with the central bank and
earn interest on it.

Bank Rate It is the rate at which banks borrow money from RBI
without any sale of securities. It is generally for a longer
period of time.

Banking Terminology (contd)
Mandatory Ratios Brief Description
Cash Reserve Ratio (CRR) Banks are required to maintain a percentage of
their deposits as cash and can use only the
remaining amount for lending/investment. This
minimum percentage which is determined by the
RBI is known as CRR.
Statutory Liquidity Ratio Apart from keeping a portion of deposits with the
(SLR) RBI as cash, banks are also required to maintain a
minimum percentage of deposits with them at the
end of every business day, in the form of gold,
cash, government bonds or other approved
securities. This minimum percentage is called SLR
Capital Adequacy Ratio It is the ratio of qualifying capital to risk adjusted
(CAR) (or weighted) assets. The RBI has set the minimum
CAR at 9% for all banks. The ratio ensures that the
bank do not expand their business without having
adequate capital.

Other ratios Brief Description
Net Interest Margin NIM is a measure of the difference between the interest
(NIM) income and the amount of interest paid out to their
lenders (for example, deposits), relative to the amount of
their (interest-earning) assets. it is calculated as a
percentage of interest bearing assets.

Current Account and It is the ratio of deposits in the current and savings
Saving Account (CASA) accounts to its total deposits. A high ratio means that the
bank is getting money at low cost, since no interest is
paid on the current accounts and the interest paid on
savings account is usually low.
Credit to deposit Ratio This ratio indicates how much of the advances lent by
banks is done through deposits. It is the proportion of
loan-assets created from the deposits received. The ratio
reflects the ability of the bank to make optimal use of the
available resources.

Asset Quality Ratios Brief Description
Non Performing asset An NPA are those assets for which interest is overdue for
ratio (NPA) more than 90 days (or 3 months). Net NPAs are
calculated by reducing cumulative balance of provisions
outstanding at a period end from gross NPAs. Higher
ratio reflects rising bad quality of loans
Provision coverage It is a measure that indicates the extent to which the
ratio bank has provided against the troubled part of its loan
portfolio. A high ratio suggests that additional provisions
to be made by the bank in the coming years would be
relatively low (if gross non-performing assets do not rise
at a faster clip).
Return on Asset Ratio Returns on asset (ROA) ratio is the net income (profits)
generated by the bank on its total assets (including fixed
assets). The higher the proportion of average earnings
assets, the better would be the resulting returns on total
assets.

Regulatory framework
Principal enactments governing the functioning of various type of
banks are :
 Banking Regulation Act, 1949
 Reserve Bank of India Act, 1934
 Foreign Exchange Management Act, 1999
 Companies Act, 1956
 Prevention of Money laundering Act, 2002
 Banking Companies ( Acquisition and Transfer of Undertakings) Act, 1970
 Securitisation and Reconstruction of Financial Asset and Enforcement of Security
Interest Act, 2002
 Credit Information Companies Regulation Act, 2005
 Income Tax Act, 1961
 Service Tax Act, 1994

Regulatory framework (contd)

Important Regulatory guidelines
Sources of Funds Important Regulatory Guidelines
Deposits from Public  Master Circular of instructions relating to deposits held in
FCNR (B) Accounts
 Master Circular on Non-Resident Ordinary Rupee (NRO)
Account [FEMA Regulation]
 Master Circular on Remittance Facilities for Non-
Resident Indians / Persons of Indian Origin / Foreign
Nationals [ FEMA Regulation]
 Master Circular on NRO Account [FEMA Regulation]
 Master Circular on KYC Norms
Borrowings from Other  Master Circular on Call/Notice Money Market Operations
 Master Circular - Guidelines for Issue of Certificates of
financial institutions / RBI Deposit
 Master Circular - Guidelines for Issue of Commercial
Paper
Capital (Owner)  Sec 11, 12 and 13 of Banking Regulation Act
 Master Circular - Capital Adequacy

Application of Funds Important Regulatory Guidelines
Lending (Advances)  Section 20 and 21 of Banking Regulation Act
 Master Circular - Loans and Advances – Statutory
Restrictions
 Master Circular – Housing finance
 Master Circular – Exposure Norms
 Master Circular – Lending to Micro, Small & Medium
Enterprises (MSME ) Sector
 Master Circular – Lending to Priority Sector
 Master Circular – Prudential Norms on Income Recognition,
Asset classification and provisioning pertaining to advances
 Master Circular – Bank Finance to NBFC
 Master Circular – Willful defaulters
Investments  Master Circular – Prudential Norms for classification ,
valuation and operation of investment portfolio by banks
 Master Circular on CRR and SLR
 Sec 24 of Banking regulation Act [SLR]
Deposits with other financial  Master Circular on Call/Notice Money Market Operations
institutions / RBI

Cost / Income Important Regulatory Guidelines
Interest Expense (on  Master Circular - Interest Rates on Rupee Deposits held in
Domestic, Ordinary NRO, NRE accounts
Deposits and Borrowings)
Interest and Divided  Master Circular - Interest Rates on Advances
 Master Circular – Prudential Norms on Income Recognition,
Income (on Advances and Asset classification and provisioning pertaining to advances
Investments)
Other Income / Expenses  Master Circular – Para Banking Activity
 Service Tax Act
Provisions and  Master Circular – Prudential Norms on Income Recognition,
Asset classification and provisioning pertaining to advances
Contingencies  Income Tax Act , 1961.
- Provision on Assets
- Provision for tax

Appropriation  Sec 17 of Banking Regulation Act
 Statutory reserves  RBI Circular dated September 20, 2006
 Dividend to Shareholders

Other General Important Regulatory Guidelines
 Master Circular - Disclosure in Financial Statements - Notes to Accounts
 Master Circular on Customer Service in Banks
 Master Circular on External Commercial Borrowings and Trade Credits
 Master Circular on Acquisition and Transfer of Immovable Property in India by
NRIs/PIOs/Foreign Nationals of Non- Indian Origin
 Guidelines on Fair Practices Code for Lenders

 Code of Banks Commitment to Customer [IBA]

 Guidelines on Managing Risks and Code of Conduct in Outsourcing of Financial
Services by banks

Compliance function

Who has to ensure compliance with all the statutory provisions
contained in various legislations?

RBI has issued circular dated April 20, 2007 on „Compliance
functions in banks‟ which states:

The Compliance Function has to ensure strict observance of all
statutory provisions contained in various legislations and also each
bank's internal policies. [Introduction Para]

Compliance function in banks is one of the key elements in the
banks‟ corporate governance structure. [Preamble]

Compliance function (contd)
Significance of Compliance function

 Identifying the level of compliance risk in each business line, products and
processes and issue instructions to operational functionaries / formulate
proposals for mitigation of such risk.

 The compliance risks in all new products and processes is thoroughly
analyzed and appropriate risk mitigants by way of necessary checks and
balances are placed before launching.

 Dissemination of new instructions / guidelines issued by the regulatory
authorities across the Bank to ensure that the business and functional units
operate within the boundaries set by regulators.

 Reference point for the bank's staff for seeking clarifications/ interpretations
of various regulatory and statutory guidelines

What is Compliance risk?

 Compliance risk is defined as “the risk of legal or regulatory sanctions, material financial
loss, or loss to reputation a bank may suffer as a result of its failure to comply with laws,
regulations, rules, related self-regulatory organization standards, and codes of conduct
applicable to its banking activities” [Para 2.1]

Who is responsible to manage Compliance risk?

 The Board would be responsible for ensuring that an appropriate compliance policy is in
place in the bank to manage compliance risk and also overseeing its implementation.
[Para 3.1]

Reporting of Compliance failures

 Instances of all material compliance failures which may attract significant risk of legal or
regulatory sanctions, financial loss or loss of reputation should be reported to the
Board/ACB/Board Committee promptly. [Para 7.4]

 Non-compliance with any regulatory guidelines and administrative actions initiated against
the bank and or corrective steps taken to avoid recurrence of the lapses should be
disclosed in the annual report of the banks. [Para 6.13]

Compliance Process and Procedure
 The Board of Bank has established Compliance Department for
implementations of the Compliance function and ensuring that operating
and business units comply with regulatory guidelines.

 The Compliance department has appointed Nodal Compliance Officers
within each operating and business units for implementations of the
Compliance function.

 The Compliance department of Bank also perform the following critical
function:
 Monitoring and identification of suspicious transactions as per
Prevention of Money Laundering Act, 2002
 Fraud Monitoring and reporting
 Managing the risk associated with outsourcing of the activities of the
Bank

Compliance function

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Editor's Notes