Understanding RBI section 35 Inspection

Bank officers generally consider RBI inspection as an external audit inasmuch as it is not going to matter in their career progress. They also believe as some event that can be managed as it happens. The feeling of insignificance or lack of seriousness is based on two facts. Firstly, RBI inspection usually happens after the annual statutory audit. Secondly, the officers at bank branches or offices who are expected to interact with RBI  inspectors are found to be new and ignorant of the complete background of accounts after their annual transfers. The predicament awaiting RBI inspectors is irritating. As a result, banks pay a huge price in the form of additional provisions, reclassification of assets, income booking profit calculation and difficulty to sort out remarks on board level functioning.

RBI inspection of banks is usually known as ‘RBI section 35 inspection’. The Banking Regulation Act, 1949 (10 of 1949) empowers the RBI to conduct inspection of banks and report to the government. 

The inspectors are officials deputed from nearby RBI offices. They focus on compliance of bank branches to licensing terms and to ensure that their functioning is not detrimental to the interests of the depositors. They also have a look at the overall quality of assets of the banks, and systems and procedures followed that contribute to the stability of the banking system. 

One has to give credit to the regulators for a stable banking scenario in India by timely interventions and removing unethical banks from the scene. While bank officials may view there to be a lack of pragmatism in RBI inspectors, RBI officials see the inadequacy of training among bank officials in implementing RBI instructions.

Unlike the statutory auditors, RBI inspectors offer better interpretation of RBI instructions. Their reporting of instances of serious violations can lead to cancellation of the licence of a branch or pave way for proceedings that lead even for liquidation of a bank. The on-site inspection is complementary to off-site inspection. The Off site supervision is at bank level and is based on reports known as DSB returns submitted by banks and minutes of the quarterly discussions with the chairman and other senior executives of banks. 

The DSB returns collect data covering:

• Assets liability and off balance sheet exposure
• Capital adequacy
• Operating results
• Asset quality
• Large credit
• Ownership & control
• Forex
• Liquidity
• Frauds

Logically,  the common topics for quarterly informal discussion used to be the following: 

• Wrong classification of accounts detected during inspections as performing assets
• Inadequate provision made for bad loans 
• Computation errors in claiming subsidy from the government 
• Performance of the branch opening vis a vis the target performance
• Application of correct risk weights for assets while computing capital adequacy 
• Frauds and media coverage of scams  
• Functioning of management, mainly transmission of RBI instructions to their operating units for implementation 
• Profitability of branches 
• Omissions, if any, in the maintenance of funds with the RBI for CRR and investments for SLR requirements 
• Compliance-related issues 

The discussions are followed by exchange of minutes containing action plans that are monitored for compliance. 

Strong character of this inspection.

There can be instances when we come across news story that reads  “RBI’s directives under Section 35A(1) of the Banking Regulation Act, 1949 and based on an inspection and scrutiny under Sections 35 and 35(1A) of the Act of 1949 wherein financial irregularities, malfeasance, misfeasance and breach of trust by the Board of Directors of the Bank etc. were prima facie found. Sometimes it is the chairman who is named. Or some other time the CEO is asked to quit or to go on leave abruptly. 

Sensational and sensitive

Details of discussions between bank officials and RBI officials, taking place as part of regular monitoring, is not available for public discussion, keeping the fiduciary character of banking intact.  Moreover, that privacy provides bank officials with some time to repair or rectify the damage caused by any negligence pointed out. However, repetition of any error or violation of instructions,  pointed out during inspection by inspectors or during discussions with the Reserve Bank Regional director, leads to closer scrutiny of all related transactions and monitoring of the official. Ultimately, suitable action is initiated to save the bank and the banking system. 

Be prepared for professionalism 

Here are a few tips for bank officials can follow to avoid becoming a victim of this exercise:

• Superior character of RBI instruction: Individual bank instructions are primarily based on RBI guidelines. While rephrasing or simplifying,  banks sometimes miss some critical points. During RBI inspections, the misinterpretation surfaces and debate takes place. Overlooking some age-old instructions while rephrasing can also cause the damage. Therefore it is worth reading RBI instructions and comparing it with the instructions of banks to ensure both are on the same lines. In case of any ambiguity,  one may contact the local RBI office.  (There used to be issues with terms ‘infrastructure’,  ‘provisions’ etc.) A change in grouping,  based on revised interpretation, can impact at bank level, Some of these impact reported figures on Non-performing assets,  Provisions made on assets,  Profit booked etc. Sometimes,  it may be necessary to write to the bank’s own head office so that all offices comprehend instructions similarly. 
• Ignorance about the power of RBI inspectors to call for any information during inspection. Section 27 of Banking Regulation Act 1959 provides them adequate powers to call for information. An inspector can, if he feels so,  get untruthful information to be provided under oath. The introduction letter presented to the Manager of an office is their mandate to access records. It is not prudent to deny information or manage without providing inadequate information. This can lead to initiating a spot audit that can trigger unmanageable repercussions on the whole bank.
• RBI inspection is coordinated by a single Principal Inspection Official appointed for each bank. Therefore, inspection of a branch or a department,  is not to be seen as a task in isolation. It is a process that gets initiated from an office and then extends via other branches, continues throughout the year and lies entangled among common clients with other banks. It is prudent to update information of  our clients about their other bank accounts. 
• Statutory auditors are chartered accountants with adequate experience to guide banks. However, as regards clarity on RBI instructions,  we must accept that it is the views of RBI that is going to prevail in the end.
• Market intelligence offers RBI inspectors reasonable leads about poor performing clients in their area of operation. Therefore, bank officials must keep news about clients appearing in the media, enquire with the client for explanation and file the details conveniently. Thus they can be ready with proper explanations of rumours, baseless news stories circulating in the media and publicity.
• Monetary and Credit information is a monthly publication that may be of a ten minute reading. It’s worth reading it regularly. One may follow up at the RBI site,  with that information depending upon their need.

In conclusion,  all bank officials facing RBI section 35 inspection have to understand the objective of RBI inspection. 

RBI has to

• ensure solvency of banking system, quality of bank assets,  adequate liquidity, competency of management and profitability
• safeguard interest of depositors
• ensure compliance of statutory and regulatory requirements
• oversee the implementation of national socio-economic policies

This article is a brief introduction to the role of RBI inspection of banks and its offices. I presume it helps to encourage you to dig deep on this subject.