Banking sector is the most important segment in the financial system of any country. As most of the economic activities are supported and provided funds by the banks, efficient and profitable functioning of banks are indicators of healthy and vibrant economy of a country.

The supervision of banks is generally entrusted to the Central Bank in every coun­try. In India, supervision of commercial banks is carried out by the Department of Banking Supervision (DBS) of RBI.

The supervision of co-operative banks and Regional Rural Banks is carried out by NABARD. RBI also conducts inspection of Development Financial Insti­tutions like NABARD, IDBI, etc., and also of registered Non-Banking Financial Compa­nies.

Objective of Supervision:

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The primary objective of supervision is to ensure safety of funds placed by depositors with banks and to retain the confidence of depositors, inves­tors and clients in the banking system. Therefore, the objective of supervision is also to ensure the solvency and liquidity of every bank.

It also ensures that banks are following the instructions and directives of Central Bank issued on various aspects of banking activities. It is required to identify deficiencies and irregularities in the working of banks and provide early warning system to avert any financial crisis in the banks.

In short, the objective of banking supervision is to ensure the overall financial health, liquidity, solvency, and profit­able operations of every bank.

Legal Framework for Supervision:

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The legal framework for banking supervision is provided by the Banking Regulation Act, 1949. Section 35 of this Act, empowers Reserve Bank of India to conduct supervision/inspection of Commercial Banks to ensure that banks are operating in a sound financial system and the interest of depositors are not jeopardized by the banks.

The supervision /inspection of Co-operative Banks and Regional Rural Banks are conducted by NABARD under the same section of Banking Regulation Act, 1949. Inspec­tion of Non- Banking Financial Institutions is conducted in terms of provision contained in Section 45N of RBI Act.

Method of Inspection:

The Reserve Bank normally conducts two types of inspection viz., (i) on-site inspection and (ii) Off-site surveillance.

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(i) On-site inspection:

Under this system, the Reserve Bank sends its team of officers to various banks (Head Office, Zonal Offices, branches, etc.,) to inspect the books of accounts, examine Loan and Advances accounts, Balance Sheet Verification, examination of Invest­ment Accounts etc.

The team will verify whether requisite provisioning has been made against doubtful assets and the true financial position of the bank has been revealed in the final accounts. The team suggests measures to improve the operational efficiency of the bank and to cut down wasteful expenditure.

(ii) Off-Site Surveillance:

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The purpose of off-site surveillance is to find out on-going basis to ascertain whether the bank’s financial condition is sound; whether the bank is maintain­ing requisite CRR and SLR; whether the bank is complying with policy measures announced by RBI from time to time etc.

These aspects are verified by calling for periodical statements and Returns from Banks. Since this type of examination is conducted away from the banks whose affairs are being analyzed and in the offices of RBI, it is called off-site inspection or surveillance.

This system introduced in 1995 serves as an early warning signal to RBI about the impending deterioration in a bank’s affairs.

Type of Inspection:

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Prior to 1991, the Reserve Bank was conducting two types of inspec­tion, viz., financial inspection and Annual Financial Reviews.

However, presently RBI is conducting Annual Financial Inspection of Commercial Banks mainly with a view to assess the true financial strength of the bank.

This is done under a system known as CAMELS which stand for Capital Adequacy, Asset Quality, Management, Earning, Liquidity and System. This system is mostly adopted while carrying out on-sight inspection.

Board for Financial Supervision (BFS):

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From 1994 supervision and inspection of all financial institutions except co-op Banks and Regional Rural Banks were brought under the control of RBI. Within the co-op banks supervision and inspection of urban co-op Banks vest with the jurisdiction of Reserve Bank.

Inspection of Commercial Banks and conduction by the Department of Banking Supervi­sion (DBS). Inspection of registered Non-Banking Financial institution is conducted by De­partment of non-banking financial Institutions. Inspection of Development Financial Institu­tions like IDBI, NABARD, etc., is conducted by the Financial Institutions cell.

The Urban Banks Department and Exchange Control Department carry out inspection on the operations of urban co-op banks and foreign exchange operation of commercial banks respectively. This apart, these departments particularly DBS receives a number of periodical returns and state­ment from the bank relating to their operational and financial strength.

The various departments report their findings ascertained through inspection and off­side monitoring system to the Board for Financial Supervision. (BFS) which is the apex/ supreme body to monitor and give direction to the various financial institutions.

The BFS meets once a month, reviews the reports of various departments and issue directions to take corrective measure to improve the financial help of the concerned institutions.

The BFS consists of eminent personalities in the field of financial operation, accounting practices, economic matters, etc. This body is headed by Governor of RBI and two of its Deputy Governors are also members of BFS.

Supervision and Inspection

Supervision, as a matter of fact, relates to overseeing regulatory measures – as guidelines. For example, prescription of prudential norms or Asset – Liability Management System. Inspection refers to examination (of books of accounts), detection of wrong doings like frauds, etc.