Financial majors fall short of norms

REPORT ON TREND AND PROGRESS OF BANKING IN INDIA 2006-07

Financial conglomerates neither have group-wide oversight mechanisms nor do they follow enterprise-wide risk management practices, according to the findings of a monitoring exercise by the Reserve Bank of India (RBI), Securities and Exchange Board of India (Sebi) and Insurance Regulatory and Development Authority (Irda).

The RBI has also found instances of non-reporting of certain transactions between the group companies and significant investments into units of group mutual funds and mortgage-backed securities issued by the other group companies.

A financial conglomerate is a group having a significant presence in at least two of the five accepted financial market segments in India. This includes banking and non-banking financial operations, insurance and mutual fund businesses.

The major banking conglomerates include State Bank of India(SBI), ICICI Bank and Housing Development and Finance Corporation (HDFC), all of whom have insurance and mutual fund subsidiaries.

Under the framework for monitoring of financial conglomerates, the groups are required to report quarterly returns. This facilitates monitoring of intra-group transactions and group wide-risks.

The dominant entity in the group, referred to as the designated entity, is responsible for forwarding the returns to the regulator.

The RBI has been obtaining data from the dominant entity in the group, known as the designated entity for the 12 financial conglomerates under its supervision, in which a bank is one of the counterparties.

"The analysis of FC returns had raised certain issues such as commonality of auditors and directors, directors being employees in other group companies, intra-group movement of executives having implications of 'arm's length' relationship, confidentiality of customer data, commonality of back-office arrangements and service arrangements between group companies," said the RBI in its report on trends and progress of banking in India for 2006-07.

The report added that there are also issues of significant investments in the units of group mutual fund companies and mortgage-backed securities issued by group companies and non-reporting of intra-group transactions, including large letter of comfort transactions.

The regulators also discuss group matters with the chief executives of major group entities every six months.This includes issues pertaining to group-wide risk management, oversight structure and intra-group transactions.

The RBI said that the half-yearly discussions revealed the absence of a group compliance policy and assessment of capital needs. The financial conglomerates also lacked a policy on intra-group transactions and exposures.

Besides there is no applicability of 'fit and proper' criteria for the directors, CEO and shareholders, issues related to group-wide liquidity management policy, identification and management of concentration risk, implementation of the Reserve Bank's guidelines on outsourcing and capital market exposure and frauds in the group entities.

In an effort to strengthen the supervisory efforts, the regulators have decided to jointly study the account books and other operations of financial conglomerates.

This would provide an oversight into the activities of the major group entities, the RBI had said in its annual report for 2006-07. The three regulators have also decided to engage in direct dialogue with the principal auditors of financial conglomerates to convey the supervisory concerns more effectively.