Bank Regulation and Central Bank Policy for Bfis

UNIT 5- Bank regulation and central bank policy for BFIs

Bank Regulation concept:

Bank regulation is a form of  central bank regulation  which subjects  banks to certain requirements, restrictions, designed to create market transparency  between banking institutions and the individuals and corporations with whom they conduct business, among other things .

Bank regulation is the laws and bureaucratic rules governing banking. Examples of bank regulations include  capital requirements and limits on interest rates. The formulation and issuance by authorized agencies  of specific rules and regulations, under governing law, for the conduct and structure of banking. BFIs regulation department of NRB is responsible for policy related and regulatory matters regarding BFIs which are categorized as A, B, C and D class license for commercial banks, development banks, finance companies and microfinance development banks respectively. This department also monitors  domestic financial stability report bi -annually.

At present, there are 22 major directives issued by NRB to regulate BFIs based on international banking norms and standard.

• As per the syllabus, major prudential regulation of central bank are:

Capital adequacy, loan classification and provisioning, corporate good governance and black listing.

1. Capital adequacy describes the minimum capital adequacy requirements for BFIs based on Basel capital guidelines. Further, the directives provides guidelines for prompt  corrective action for non-compliance/shortfall in required capital adequacy ratios.(See page no. 1 of NRB unified directives for more details)
2.  Loan classification and provisioning :

The NRB has categorized loan and advances and classified them on the basis of period of past dues (good, sub-standard, doubtful and bad ) along with other subjective criteria, which are defined  to access to quality of loan.( see page no. 45 of NRB unified directives, directive no. 2067)

1. Corporate governance-:

This regulatory directive of NRB incorporates the role and responsibilities  of board of directors chief executive officer; and senior management of BFIs. It also provides roles and responsibility of audit committee and also includes  prohibition for going against  the interest of institution and depositors and other minimum codes of conduct.(see page no. 194 of NRB unified directives for more details)

1. Blacklisting the borrower, who has obtained loan from BFIs and has not paid that amount. The credit information bureau, shall, within 15 days ascertain the name list recommended from the concerned licensed BFIs for blacklisting.(see page no. 315 of NRB unified directives for more details)

Objectives of Bank regulation-:

• Prudential – to reduce the level of risk to which bank creditors are exposed (i.e to protect depositors)
• Systemic risk reduction- to reduce the risk of disruption resulting from adverse trading conditions for major bank failure.
• To avoid misuse of banks- to reduce the risk of banks being used for criminal purposes.
• To protect banking confidentiality
• Credit allocation- to direct credit to favored sectors.
• Treating customers fairly and having corporate social responsibility.

Need and significance of regulation

The necessity for public intervention in the economy has traditionally been justified by the need to correct market imperfections and unfair distribution of resources. Hence, the main objectives of such intervention: pursuit of stability, equity of resource allocation and efficient use of resources. From this perspective, financial regulatory mechanisms and regulation of the banking industry in particular can be considered extremely important. Capital accumulation and allocation of financial resources are crucial to economic development of each country. 

Regulation and supervision of the business activities, pertaining to the banking industry units will be essential for their effective functioning. Generally, the concept of banking regulation and supervision is defined as control over the creation, operation, and liquidation of banks. 

The most general definition of the concept of banking regulation and supervision is control over the creation, operation, and liquidation of banks. Such control is very diverse, carried out by specialized banking supervisory authorities. Supervision over the bank’s operational activities aims to protect the interests of depositors and to ensure effective functioning of the banking industry units. This supervision is the most important and essential part of the functions of banking supervisory authorities, which is carried out in the name of a sound banking system. Supervision is performed continuously throughout the whole operating process of the bank. 

Although banking regulation and supervision is generally focused on the financial state and business performance of individual banks, its main purpose is to maintain stability of the banking industry. To achieve this goal, banking supervision takes precautions for preventing loss to depositors, and thereby helping to sustain public confidence in banks and the banking industry as a whole. The role of banking regulation and supervision is to create an environment, which supports only reliable and prudent banks and reduces excessive risk-taking.

Furthermore, banking supervision is required in order to monitor and assist in the early detection of problems in the banking institutions, taking all necessary measures, such as liquidation, with the aim of overcoming and limiting the adverse effects within the affected bank. 

The banking industry plays a very important role in the development of national economies. Moreover, since borders between the economies of separate countries are progressively losing importance, banks are gradually being incorporated into the global economy. Their role and importance is steadily increasing and today, they represent major players on the market both at domestic and international level. 

Banking supervision in different countries is characterized by a high degree of uniqueness, resulting from the specificities of the relevant national economy and banking industry. However, supervisory authorities in each country tend to have common goals, related to ensuring the availability of reliable and well-managed banks which do not jeopardize the interests of depositors. 

Banking supervision should be seen as a dynamic function, responding to market changes. Therefore, national supervisory authorities and international departments should periodically adapt their policies and practices to the changes in economic environment. The legal framework in each country, concerning the banking system, should be flexible enough to allow national supervisors to make those changes. The effective operation of future authority for banking supervision depends on: institutionalization of banking supervision; defining its rights and obligations; creating links with other participants in the banking and insurance network; the presence of laws regulating the creation, ownership, rights, and responsibilities of business organizations, property laws, insolvency and bankruptcy law; the application of the accounting world standards, practices and systems; the presence of an independent external audit and public disclosure of financial audits. All these conditions create a healthy business environment which reduces the risk in the banking industry.