Risk Based Supervision of Banks – Framework for Risk Assessment

Abstract

With progressive deregulation and liberalization of the Indian financial sector, banks are increasingly exposed to various kinds of risk, both financial and non-financial. Efficiency of every bank depends on how effectively it is managing the risks and ensuring a competitive risk adjusted return on capital. For this, it is essential to have in place effective risk management and internal control systems, which are crucial to the conduct of banking business not only to lead the bank more profitably but also in compliance of prudential guidelines. In addition, a supervisor i. e. Reserve Bank of India (RBI) also looks upon the systems and practices in banks in assessing, managing and controlling risks through Risk Based Supervision (RBS), wherein the supervisory resources are directed towards the areas of greater risk to the supervisory objectives which aim at protecting the interest of depositors, stability of the banking system and development of banks as agents of economic growth. Under the RBS approach, the supervisory process would also seek to leverage the work done by internal auditors/inspectors in banks. In this regard, in August 2001, RBI had brought out a discussion paper on “Move Towards Risk-Based Supervision of Banks” in which five significant areas have been identified for action on the part of banks and Risk-Based Internal Audit (RBIA) system is one of them. This paper focuses discussion on RBIA. In this paper, it is attempted to develop the framework for risk assessment as part of RBIA. The suggested framework is easy to understand and based on the on-site audit conducted by the internal auditor/inspector. Since banks are currently busy in preparatory work relating to switch over from internal audit/inspection to RBIA, the suggested framework is lot of relevance. Researchers in Audit and Inspection may like to refine the suggested framework.