28Prudential Regulations 2002

8/10/2019 28Prudential Regulations 2002

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RMA/FRSD/PR (FIs)/V3-2010

Foreword

In exercise of the powers conferred by the Royal Monetary Authority of Bhutan Act,

1982 and Financial Institutions Act of Bhutan 1992, the Royal Monetary Authority

hereby issues these regulations to the financial institutions in Bhutan. These regulationsshall come into force from 1 June 2002 and supersede the existing Prudential Regulations

1999. However, different dates have been prescribed for the coming into force of

different Sections or subsections of these regulations.

While these regulations provides a broad framework of quasi-judicial responsibilities thatthe financial institutions will have to adhere to and implement at the minimum, the

financial institutions are allowed to have their own stringent policies and procedures that

are approved by their respective Boards.

In the interpretation of these regulations, the RMA has incorporated certain minimum

standards of 25 Core Principles for Effective Banking Supervision, which is beingpromulgated by the Basel Committee for Banking Supervision, BIS. In doing so, whilesome consideration has been given to achieve the minimum international best practices,

the RMA has also taken into account the ground realities and practical conveniences of

the financial sector as a whole.

The RMA hopes that the Prudential Regulation 2002 will facilitate the smooth

implementation of all the prudent practices and inculcate proper risk managementtechniques amongst the financial institutions. Besides, these regulations shall also

promote the same level of playing field for all market players, including transparency,

accountability, corporate governance and fair competition. It is the RMAs expectation

that all the financial institutions shall comply and implement these regulations in aneffective manner.

These regulations shall be amended in part or as a whole when the RMA feels the need toaffect such changes.

Thanking you,

Sonam Wangchuk

Managing Director


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Contents

Section Page

1 Regulations on Directors and Chief Executives in the FinancialInstitutions:RMA/PR-1/2002 11.1 Introduction 1

1.2 Duties and Responsibilities of the Board 11.3 Appointment of Directors and Chief Executives 3

1.4 Prohibition of Interlocking Directorship 4

1.5 Chief Executive 5

Schedule- I

Structures and Duties of the Audit Committee:RMA/PR-1A/2006 6

Schedule-II

Internal Audit Requirements:RMA/PR-1B/2006 8

2 Regulations on Related Party Transactions:RMA/PR-2/2002 9

2.1 Introduction 92.2 Definition of Related Party 9

2.3 Restrictions on Lending to Significant Owner, Directors, Officers &

Employees 102.4 Granting of Favored Terms Prohibited 11

2.5 Restrictions on lending to legal entities related to the Financial

Institutions as specified under Article 48 of FI Act 1992 & Section2.2 of PR 2002 11

2.6 Restrictions on Purchase of Goods & Property Obtained by theInstitution in Satisfaction of Debts 12

2.7 Reporting of Related Party Transactions 12

3 Regulations on the Code of Ethics for Directors and employees

of the Financial Institutions:RMA/PR-3/2002 133.1 Introduction 13

3.2 Principles of Ethical Conduct 133.3 Monitoring Devices 16

3.4 Code of Ethics (Minimum requirement) 17

3.5 Financial Institutions Code of Ethics 173.6 No Recruitment of Employees Terminated from services of other 17

Financial Institutions/Other Agencies

4 Regulations on Shares Trading: RMA/PR-4/2002 18

4.1 Introduction 18

4.2 Article 46 of the Financial Institutions Act 19

4.3 Loans against Shares or Loans for the Purchase of Shares 194.4 Information on Significant Owner 19

4.5 Compliance requirements for the RSEBL 19


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9.9 Supervision over & Reporting of the Evaluation & Classification of

Risk Exposures & Provisioning 489.10 Transitional Stipulations 48

9.11 Interest Regime 48

10 Regulations on Borrower Information: RMA/PR-10/2002 52 10.1 Introduction 52

10.2 Borrower Information 5210.9 Information to Clients 54

11 Regulations on Revaluation and appropriation of Reserves:

RMA/PR-11/2002 55

11.1 Introduction 55

11.2 Transfer to General Reserves 55

11.3 Provision for Foreign Exchange Fluctuation Reserve 55

12 Regulations on Dividends and Reserves: RMA/PR-12/2002 5612.1 Introduction 56

13 Regulations on Collateral and Others: RMA/PR-13/2002 57

13.1 Introduction 57

13.2 Collateral 5713.3 Registration of Mortgages and Collateral 57

13.4 Insurance of Collateral 58

13.5 Substitution of Collateral 5813.6 Third Party Guarantees 58

13.7 Financing Limit 5813.8 Information to Clients 58

14 Regulations on Share Capital Ownership of Banks: RMA/PR-14/2002 59

15 Regulations on Investment in Equity by Banks: RMA/PR-15/2002 60

16 Regulations on Share Capital Ownership of Non-bank financial

Institutions: RMA/PR-16/2002 61

17. Regulations on Investment in Equity by Non-bank financial institutions:

RMA/PR-17/2002 62

18 Regulations on establishment of Branches, Agencies, & other such offices

of financial institutions and Launching of new products:

RMA/PR-18/2002 63

18.1 Establishment of Branches, Agencies, & other such offices

of financial institution 6318.2 Launching of new products 63


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SECTION 1

REGULATIONS FOR DIRECTORS AND CHIEF EXECUTIVES OF THE

FINANCIAL INSTITUTIONS

1.1 INTRODUCTION

1.1.1 Public confidence is the cornerstone of a stable financial system. As the custodian ofpublic funds, the management of a financial institution must exhibit impeccable integrity

and professionalism in their conduct so as to engender public confidence in the safety oftheir deposits and other financial services. In order to broaden and deepen the countrys

financial infrastructure, the need for the respective Boards of Directors to assume full

responsibility for the overall management of the financial institution has become morecrucial than ever.

1.1.2 The Board of Directors is placed in a position of trust and confidence by the shareholders.Both the statutes of the Companies Act and Financial Institutions Act, place a highdegree of responsibility on the Board of Directors regarding the affairs of an institution.

Individual Directors must be technically competent persons, with sound financial

integrity and strong sense of professionalism, who will foster and practice the higheststandards of banking and finance in the country. While the Board may delegate the day-

to-day conduct of the financial institutions business to the full-time employees of the

financial institution, it is ultimately responsible for every deed or misdeed of theinstitution. The Board of Directors is responsible for safeguarding the interests of

shareholders, depositors, creditors and others, through lawful, informed, efficient, and

able administration of the institution.

The following regulations are being issued in order to ensure the effectiveness of the

Boards of Directors of the financial institutions.

1.2 DUTIES AND RESPONSIBILITIES OF THE BOARDThe major duties and responsibilities of the Board of Directors of a financial institution

are as follows:-

(i) Select and appoint senior executive officers who are qualified and competent toadminister the affairs of the financial institution effectively and soundly. Themanagement team must be professional at all times in carrying out its duties. The Board

of Directors must ensure that the staff is competent, effective and conversant with thelaws and the relevant rules and regulations, which are issued from time to time by the

RMA and the RGOB. The staff of the institution must also be fluent with the objectivesand policies of the institution.

(ii) Supervise the affairs of the financial institution, and be regularly informed of theinstitutions condition and management policies in ensuring that the institution issoundly managed.The Directors must commit sufficient time to be fully informed of the


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condition of the business, the direction they are steering the institution to, and apply

immediate remedial measures as and when the need arises. In accordance with Part VIIArticle 82 of the Companies Act, the Board must meet at least once in every three months

and as per the prescribed rules and procedures. Although the Board may delegate certain

authority to the senior officers, it is their responsibility to supervise and deliberate on the

performance of the institution and to provide policy direction and guidance to themanagement.

(iii) Observe the relevant laws, rules and regulations.Directors must be familiar with therelevant laws, and related rules and regulations and must exercise due diligence to see

that these are not violated. The Board is accountable for any non-compliance of laws,

rules and regulations by the institution and any Director who is found to have actedimproperly is liable to have his/her directorship revoked.

(iv) Adopt and follow sound policies and objectives, which have been thoroughlydeliberated.The Board must provide clear objectives and policies within which senior

executive officers are to operate. These should cover all aspects of operations, includingstrategic planning, credit administration and control, asset and liability management,

liquidity risk, interest rate risk and market risk, accounting systems and internal controls,quality of services, automation plans, prevention of money laundering, profit planning

and budgeting, adequacy of capital, and human resource development. Clear lines and

limits of authority for all levels of staff should be well established.

(v) Avoid self-serving practices and conflicts of interest.The Directors assume a fiduciary

role and must display the outmost good faith towards the institution in their dealings withit or in its behalf. They must refrain from making any personal profit or acquiring any

undue advantage from their position as Director and must diligently observe the

Regulations on Related Party Transactions, Regulations on the Code of Ethics and

Regulations on Share Trading.In particular, a Director must disclose his/her interest in

any business which is being discussed by the Board, and no Director shall participate in,

nor be present while the Board is deliberating on any business in which he/she has adirect or indirect interest.

(vi) Ensure that the financial institution has a beneficial influence on the economic wellbeing of the people.The Board of Directors has a continuing responsibility to the nation

to provide those financial services and facilities, which will be conducive to the well-

balanced growth of the economy. In line with this responsibility, the Board must ensurethe availability of credit and financial services to all sectors of the economy and all parts

of the country at a reasonable cost.

(vii) Establish and ensure the effective functioning of an Audit Committee.In terms of Part

VIII, Article 56 of the Financial Institutions Act of Bhutan 1992, the Board of Directors

and shareholders are required to ensure the establishment of an effectively functioning

Audit Committee, consisting of three members, including at least one member of theBoard of Directors. The power to appoint members of the Audit Committee of each


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institution has been delegated to the institutions shareholders. The structure and duties of

the Audit Committee is provided in Schedule I: RMA/PR-1A/2006, of this regulation.

(viii) Set up an effective Internal Audit Cell1.Part III, Article 12 (1c) of the Financial

Institutions Act requires every financial institution to establish an effective

internal audit unit. The internal audit unit must be staffed with qualifiedpersonnel, whose main responsibilities should be to perform the traditional

function of audit of the financial accounts as well as management audit.

Management audit is an audit of the management rather than an audit for themanagement, which would directly contribute to the attainment of corporate

goals. In order to enhance the independence of the internal auditors and to achieve

their audit objectives, the Board of Directors must ensure that the internal auditorshave full access to all records, and are given an appropriate standing in the

organizations hierarchy. It is therefore emphasized that the internal auditors

should be placed under the direct authority and supervision of the Audit

Committee.

1.3 APPOINTMENT OF DIRECTORS AND CHIEF EXECUTIVES

1.3.1 Every financial institution shall have a Board of Directors comprising of not less

than five directors, including the Chairman with at least one independent Director

who may be outsourced.Independent directors shall mean directors who apartfrom receiving director's remuneration do not have any other material pecuniary

relationship or transactions with the company, its promoters, its management or

its subsidiaries, which in the judgment of the board may affect their independenceof judgment.

2

1.3.2 The Chief Executive Officer shall be one of the Board of Director and the Deputy

Chief Executive Officer shall be the Member Secretary. However, the Deputy

Chief Executive Officer shall have no veto power.3

1.3.3 All financial institutions shall obtain prior approval of the RMA for the

appointment of board of directors and chief executive officer.4

1.3.4 The Directors shall be appointed by the shareholders from amongst persons who

have the required professional knowledge and experience. A person shall not be

eligible to be a Director or Chief Executive of a financial institution, if he/she:-

(i) has not attained the age of at least 30 years;

(ii) is not a citizen of Bhutan, unless this requirement is waived by the RGOB;

1Amended on 22ndJuly 20042Amended on 22

ndJuly, 2010

3Amended on 22ndJuly, 20104Amended on 22ndJuly, 2010


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(iii) has been at any point of time, convicted in a court of law of an offenseinvolving moral turpitude, or has been sentenced to imprisonment;

(iv) has been declared bankrupt, or bankruptcy proceedings have been filedagainst him/her in a court under the Bankruptcy Act;

(v) has been dismissed or suspended for any reason from his/her previousemployment, or has been subject to investigation by a statutory authority

for doubtful transactions;

(vi) has been a Director of, or was directly concerned in the management of acorporation wound up by court, or of a corporation or financial institutionwhose license was revoked by the RGOB or the RMA.

(vii) his/her loan account with any of the financial institutions is classified asnon-performing at any point of time, and has remained so, for more than

90 days.(viii) When any fact arises during the tenure of office of a Director or ChiefExecutive which makes him/her ineligible to continue in the post, theBoard shall, upon being satisfied of the fact, declare his/her office vacant.

1.3.5 The composition of Board of Directors should be such that minimum5two of thefive directors must have more than five years experience in banking, finance,

insurance and other related business of the financial institutions.6

1.3.6 As a matter of desirable practice not more than one member of a family (spouse,

children and/or economically dependent persons) or a close relative (up to secondgeneration) or an associate (partner, employee, director, etc.) should be on the

Board of the financial institution. The definition of a family or close relative

provided by the RMA shall be binding.7

1.4 PROHIBITION OF INTERLOCKING DIRECTORSHIP

1.4.1 In order to avoid conflict of interest situations in the management of two or morefinancial institutions, interlocking directorship in the financial industry is

prohibited. Thus:-

(i) a Director/an employee of one financial institution is not permitted to serve asa Director on the board of another financial institution.

(ii) any person who directly or indirectly holds more than 5 percent of the paid-upcapital of a financial institution shall not be eligible for appointment as a

Director on the board of another financial institution.

5Amended on July 22, 2010

6Amended on March 29, 20107Amended on July 20, 2009


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1.5 CHIEF EXECUTIVE

1.5.1 The sound operation of a financial institution depends critically on its ChiefExecutive who is directly responsible to the Board for its day-to-day operations.

The candidate for the Chief Executives post must be suitably qualified with

appropriate experience and possess a proven track record. In addition, he/she mustbe familiar with the operations of the financial institution, the regulatory

framework, the state of internal controls, as well as current issues and policies

affecting the financial industry in general.8Every company shall appoint a Chief

Executive Officer for a term not exceeding five years at a time with the approval

of the company in general meeting.

1.5.2 It is the duty of the Chief Executive to keep the Board fully informed of all

aspects of the institutions operations. The RMA holds the Chief Executivedirectly responsible for any lapses in the operation of the institution due to his/her

failure to inform, or obtain the approval of the Board.

1.5.3 Being the full-time staff of a financial institution, the Chief Executive has amoraland professional responsibility to devote his full attention and commitment to theday-to-day operations of the financial institution. Therefore, the Chief Executive

of a financial institution is not allowed to hold an executive position in any other

company. However, he/she may serve in a non-executive capacity on the Boardsof other companies, subject to a maximum of 5 directorships at any point of time.

In other words, besides serving as the Member Secretary to the Board of thefinancial institution, he/she may hold directorships in 4 other companies.

1.5.4 A financial institution having shareholding interests in more than four companies

may appoint the Deputy Chief Executive to participate in rest of the Boardmeetings of the other companies. Likewise, the same could be delegated to other

senior officers of the institution, if the Deputy Chief Executive has already been

appointed as director to the Boards of five companies.

8Amended on 3rd August 2004


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SCHEDULE - I

STRUCTURE AND DUTIES OF THE AUDIT COMMITTEE9

(i) In terms of Part VIII, Article 56 of the Financial Institutions Act of Bhutan1992, the Board of Directors and shareholders are required to ensure the

establishment of an effectively functioning Audit Committee, consisting of three

non-executive directors who are independent of management10

. The power toappoint members of the Audit Committee of each institution has been delegated to

the institutions shareholders.

(ii) The objectives of having an Audit Committee is to review the financial condition

of the financial institution, its internal controls, and to recommend appropriate

remedial action regularly. The Audit Committee shall meet ordinarily once per

quarter and extraordinarily when convened by the Board of Directors. Decisions

shall be taken by majority of the members present and no abstentions shall beallowed.

(iii) The primary responsibilities of the Audit Committee are as follows:-

(a) Ensure that the accounts are prepared in a timely and accurate manner.

(b) Review the balance sheet and profit and loss account for submission to the

Board of Directors and ensure the prompt publication of annual accounts.

(c) Review internal controls and procedures, including the scope of theinternal audit program, the internal audit findings, and recommend action

to be taken by the management. The reports of internal auditors and the

Audit Committee should not be subject to clearance by the Chief

Executive or the operating management.

(d) Review with the external auditors, the scope of their audit plan, the

system of internal accounting controls and procedures, the audit reports,the assistance given by the management and its staff to the auditors and

any findings and action to be taken. The Audit Committee should also

select external auditors from the panel of external audit firms enlisted bythe Royal Audit Authority (RAA). The selected audit firm must be

submitted to the Board for appointment and then to the RMA for

subsequent concurrence, each year.

(e) The Audit Committee shall also monitor compliance with laws and

regulations applicable to the institution and report to the Board of

Directors such situations as it feels should be reported. Further, review any

9Amended on 22ndJuly 200410Amended on 12thJanuary, 2006.


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related party (insiders) transactions that may arise within the financial

institution.

(f) The Audit Committee may deliver opinions on any matters presented to it

by the Board of Directors.

(g) The Audit Committee, if necessitated, may be assisted by experts specially

appointed or engaged for such purposes.

(h) Directors, managers and other officers of an institution must notify the

Audit Committee of any error or misstatement of which they become

aware in any account, report or information provided under this part.

(i) The external and internal auditors of a financial institution should have

free access to the Audit Committee. The auditors should be allowed to

attend and be heard at any meeting of the Audit Committee. Upon the

request of the auditors, the Chairman of Audit Committee should convenea meeting to consider any matter that the auditors believe should be

brought to the attention of the Directors or shareholders.


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SCHEDULE II

INTERNAL AUDIT REQUIREMENTS

1.1 INTERNAL AUDIT

(a) It is mandatory for all the financial institutions to have an Audit Committee

fully supported by an adequate team of internal auditors, who are competent,professionally trained and recruited as full time auditors.

(b) Each financial institution shall have a minimum of three internal auditors

headed by a senior officer, whose position should be equal to or higher than a

Deputy General Manager.

(c) The objectives of having internal audit is to review internal control functions,

check and verify that correct operational procedures are being followed, and

monitor accuracy of the financial transactions and records in accordance withsound accounting principles, on a regular basis.

(d) An internal audit cell must prepare a detailed audit plan covering all auditable

areas and should include a schedule of all audits each year. However, the audit

program must be revised periodically during the year when circumstances change,and such changes should be clearly explained and presented to the Audit

Committee or Board for approval.

(e) Internal auditors shall also keep a track of compliance level being followed by the

management of the institution, specially relating to policies, resolutions and rulesapproved by the Board of Directors. It shall also ensure that the institution abide

by the relevant laws, regulations and notifications issued by the RGOB and RMA,

from time to time.

(f) Internal Auditors shall normally submit their reports and findings to the Audit

Committee and the Board of Directors. However, on matters of great exigencies,

if the auditors feel the need to present their findings to the shareholders, they maydo so. Such reports shall also be made available to the RMA Examining Officers

during the time of on-site inspections, and, when such reports are being called by

the RMA.


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SECTION - 2

REGULATIONS ON RELATED PARTY TRANSACTIONS

2.1 INTRODUCTION

2.1.1 Misconduct and irregular practices by financial institutions typically occur

through the extension of credit to related parties without proper appraisal thereby

leading to a high degree of risk exposure to such parties, loss of credibility andpublic confidence, and subsequent losses by the institution. To prevent these

abuses and irregular practices, Articles 49 and 50 of Part VII of the Financial

Institutions Act prohibits a financial institution from granting favored terms andsets out the rules for doing business with related persons.

The regulations in this Section are intended to instill discipline and

professionalism, and to promote prudent practices in the financial industry.

2.2 DEFINITION OF RELATED PARTY

For the purpose of these regulations, a party is considered to be related if he/shehas the ability to control, or exercise significant influence over the financial

institution in making financial and operating decisions, and includes the

following:-

(a) significant owner;11

(b) a member of the Board of Directors

(c) officers and employees of the institution;

(d) spouse and children of persons specified in (a) (b) and (c);

(e) any individual for whom a director, significant owner, officer or employeeis a guarantor;

(f) any firm or company in which a significant owner, director and officer oremployee has an interest as owner, partner, or has a direct or indirect

equity interest equal to or exceeding 10 percent of the paid-up equitycapital;

(g) another financial institution with cross-shareholding in, or a high degree ofinfluence over the financial institution;

11Amended on March 29, 2010

Significant owner means a person who either acting alone or in concert with other person represents

10% or more of the capital of the financial institution or can exercise control over the management ofthe financial institution


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(h) the parent company, subsidiary ,fellow subsidiaries and affiliates of thefinancial institution.

2.3 RESTRICTIONS ON LENDING TO SIGNIFICANT OWNERS,DIRECTORS,

OFFICERS AND EMPLOYEES

2.3.1 A financial institution shall not extend credit to:-

(a) any of its significant owner beyond a maximum limit of 10 Percent of theinstitutions capital fund.

(b) any of its directors beyond a maximum limit of 10 percent of theinstitutions capital fund, and

(c) any of its officers or employees exceeding 5 percent of the institutionscapital fund.

2.3.2 For the purpose of deriving the limits specified in Section 2.3.1 above, the

following loans shall be aggregated:-

(a) loans and advances granted to the significant owner, director and officer oremployee personally;

(b) loans and advances granted to the spouse, children and to any other directdependents of the significant owner, director and officer or employee;

(c) loans and advances to a firm or company of which the significant owner,director and officer or employee is owner, partner, or in which he/she hasan equity interest exceeding 10 percent of the equity capital. Such loans

and advances shall be aggregated in proportion to the significant owners,

directors, officers or employees equity in the firm or company. Wherethe significant owner, director and officer or employee owns 50 percent or

more of the firm or companys equity stock, the total loan exposure to that

firm/company shall be aggregated.

(d) loans and advances guaranteed by the significant owner, director andofficer or employee.

2.3.3 Sanction of loans and advances to a significant owner or director beyond 5percent of the institutions capital fund and to an officer or employee beyond 1

percent of its capital fund, must have the prior approval of the Board. In otherwords, if an institutions exposure to a significant owner or director is 5 percent of

its capital fund, any further loan or advance to him/her must have the prior


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approval of the Board. Similarly, if the institutions exposure to an officer or

employee is 1 percent of its capital fund, any further loan or advance to him/hermust have the prior approval of the Board.

2.3.4 Where a default occurs in respect of any loan granted to a significant owner,

director and officer or employee, he/she shall not be eligible for any further loanuntil the loan account has been regularized.

2.3.5 A report of all outstanding loans and advances granted to significant ownerdirectors and officers or employees must be submitted to the Board at each

meeting thereof.

2.4 GRANTING OF FAVORED TERMS PROHIBITED

2.4.1 All loans to related persons (i) shall be on the same terms and conditions,

including interest rates, fees, margins and security, as those applicable at the time

of origination to similar loans to any other person who is not a related person ofthe financial institution; (ii) shall not involve more than the normal risk of

repayment or any other unfavorable features, and (iii) the financial institutionshall apply credit underwriting procedures that are no less stringent than those

applied for comparable transactions with persons who are not related person.12

2.5 RESTRICTIONS ON LENDING TO LEGAL ENTITIES RELATED TO THEFINANCIAL INSTITUTIONS AS SPECIFIED UNDER ARTICLE 48 OF FI

ACT 1992 AND SECTION 2.2 OF PR 2002.

2.5.1 A financial institution shall confirm to the following limits and requirements withregard to lending to the following related parties:

a) holding or parent13

company

b) subsidiary of the holding or parent company

c) companies in which the holding or parent company has a direct or indirectequity interest equal to or exceeding 10 percent

d) Financial institutions subsidiaries and its affiliates

2.5.2 Limits and Requirements

(a) the total of all loans outstanding to any of the above related parties shallnot at any time exceed 10 percent of the financial institutions capital

fund.

12Amended on July 20, 200913Amended on March 29. 2010


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(b) if a loan to a related party becomes a non performing loan, the financialinstitution shall deduct the total loan outstanding from its capital fundwhen assessing the capital adequacy ratio.

(c) the total of all loans to all related persons of the financial institutions shall

not exceed 40 percent of its capital fund.

2. 6 RESTRICTIONS ON THE PURCHASE OF GOODS AND PROPERTY

OBTAINED BY THE INSTITUTION IN SATISFACTION OF DEBTS

2.6.1 The sale of goods or other property seized by a financial institution in satisfactionof a debt previously contracted must be carried out through public auction.

2.6.2 Directors, officers and employees are prohibited from purchasing such goods or

property from the financial institution or any agent thereof, directly.

2.7 REPORTING OF RELATED PARTY TRANSACTIONSIn the context of this regulation, related party transactions shall be reported to theRMA in Form FIS-Q8. The report shall contain details of all loans, including

overdraft facilities and other extensions of credit, and must be submitted to the

RMA on a quarterly basis, no later than last day of the first month following eachquarter.


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SECTION - 3

REGULATIONS ON THE CODE OF ETHICS FOR DIRECTORS AND

EMPLOYEES OF THE FINANCIAL INSTITUTIONS

3.1 INTRODUCTION

3.1.1 In the business of banking and finance, the vital ingredient is confidence -confidence of the public in the safety of their deposits, and in the integrity and

professional conduct of their financial institutions. As custodian of public funds, a

financial institution has the responsibility to safeguard its integrity and credibility.

The public trust placed on the managers of financial institutions involves a heavyresponsibility. They owe it to their customers to see to it that their institutions are

professionally managed and soundly based. The Directors, officers and employees

of the financial institution, thus, must be seen to conduct their business with thehighest level of moral behavior. While employees of financial institutions may be

guided by certain informal, time-tested and generally accepted code of ethics toattain the level of conduct expected of them, the diversity and complexity oftodays financial world require that these ethical rules be codified and issued as

written regulations in order to promote and maintain a uniform ethical standard.

The following regulations are intended to set out the minimum standards of

conduct expected of Directors, officers and employees of the financial

institutions. These regulations are intended to support the financial institutions in

their efforts to uphold proper standards and do not, in any way, restrict a financialinstitution from formulating more comprehensive sets of rules in maintaining

ethical standards.

3.2 PRINCIPLES OF ETHICAL CONDUCT

The following principles are at the heart of ethical conduct by Directors, officers

and employees of the financial institutions:-

to avoid conflict of interest;

to avoid misuse of position;

to prevent misuse of information gained through the financial institutionsoperations either for personal gain or for any purpose other than that intended

by the financial institution;

to ensure completeness and accuracy of relevant records;

to ensure confidentiality of communication and transactions between thefinancial institution and its customers; and


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to ensure fair and equitable treatment of all customers and others who rely on,or are associated with the financial institution.

3.2.1 Conflict of Interest

Directors and employees must not engage directly or indirectly in any business

activity that conflicts or competes with the financial institutions interests. Theseactivities include, but are not limited to, the following:-

(a) Outside Financial Interest of Directors

The Directors of the financial institutions shall fully disclose to its Board anycommercial, financial, agricultural, industrial, or other business interests with

which they or members of their families may at any time directly or indirectly be

interested and shall refrain from voting on any matter related thereto whichbecomes the subject of Board action: provided that such an interest, if so

disclosed, shall not disqualify the interested party for the purpose of constituting a

quorum.

(b) Outside Financial Interest of EmployeesWhere an officer or employee has a financial interest in a customer, whether as asole proprietor, partner, shareholder, creditor or debtor, such an interest must be

disclosed immediately to his/her immediate supervisor. Thereafter, that staff

should not be directly involved in the financial institutions dealings with the

customer so long as the interest continues to exist.

This restriction does not apply in cases where staffs have holdings of publicly

quoted securities, unless the immediate supervisor considers the interest to bematerial, and likely to impair the objectivity of the staff concerned.

(c) Other Business Interest

It is considered a conflict of interest if a staff conducts business other than the

financial institutions business during office hours. A conflict of interest also

arises where the acquisition of any business interest, or participation in any

business activity outside the financial institution and its office hours, demandsexcessive time and attention from the staff, thereby depriving the financial

institution of the staffs best efforts on the job.

(d) Entertainment and Gifts

Directors and staff must not accept costly entertainment from customers, potential

customers and suppliers. However, staff and Directors may accept token gifts ofno commercial value, if the acceptance of such gifts would not place the staff in a

compromising position. Under no circumstances should gifts in the form of cash,

bonds, negotiable securities, personal loans, airline tickets or use of vacationproperty be accepted.


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3.2.2 Misuse of Position

(a) Staff and Directors must not use the financial institutions name or facilities forpersonal advantage in investment or retail purchasing transactions, or in similar

types of activities. Directors and staff, and their relatives must not use their

connection with the financial institution to borrow from or become indebted to

customers or prospective customers. The use of position to obtain preferentialtreatment, such as in purchasing goods, shares and other securities is prohibited.

(b) Further, staff and Directors must not use the financial institutions facilities andinfluence for speculating in commodities, gold, silver, foreign exchange or

securities, whether acting personally or on behalf of relatives. Such misuse of

position may be grounds for dismissal. Staff and Directors should also refrainfrom back-scratching exercises with staff and Directors of other financial

institutions to provide mutually beneficial transactions in return for similar

facilities, designed to circumvent these ethical regulations.

3.2.3 Misuse of information(a) No Director or staff member shall use any information which he/she may obtainin the discharge of his/her duties about the financial institution itself, or any of itscustomers, for his/her personal or financial gain.

(b) No Director or staff member shall deal in the securities of any company listed orpending listing on a stock exchange at any time when he/she is in possession of

information obtained as a result of his/her employment by, or his/her connection

with the financial institution, which is generally not available to shareholders ofthat company and the public, and which, if it were so available, would likely bring

about a material change in the market price of the shares or other securities of thecompany concerned.

(c) A member of staff or a Director who possesses insider information is also

prohibited from influencing any other person to deal in the securities concerned orcommunicating such information to any other person, including other members of

staff who do not require such information in discharging their duty.

3.2.4 Integrity of records and transactions

(a) In accordance with Article 51 of the FIA, a financial institution must at all times

maintain clearly, accurately and in complete form such accounting records andreports as are necessary to reflect the true state of its affairs, to explain its

transactions and its financial position.

(b) Financial institutions should never make entries or allow entries to be made for

any account, record or document of the financial institution that are false or would

obscure the true nature of the transaction, as well as to mislead the true

authorization limits or approval by the relevant authority of such transactions. Afinancial institution guilty of willfully making a false entry, or omitting, altering,


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abstracting, concealing or destroying an entry in the institutions books of record,

reports or documents shall be liable to the penalties under Article 58A of the FIA.

(c) All records and computer files or programs of the financial institution,

including personnel files, financial statements and customer information,

must be accessed and used only for the purpose approved by themanagement.

3.2.5 Confidentiality

(a) The confidentiality of relations and dealings between a financial institution and its

customers is paramount in maintaining the financial institutions reputation. Thus,

staff and Directors must take every precaution to protect the confidentiality ofcustomer information and transactions. In accordance with Article 23 of the FIA,

no staff or Director shall divulge information regarding any customer, or any

correspondence, accounts or dealings of the financial institution or its customers,

to any person other than administrative or judicial authorities.

(b) Business and financial information about any customer may be used or made

available to third parties only with the prior written consent of the customer, or inaccordance with arrangements for the proper interchange of information between

financial institutions and Credit Information Bureau14

about credit risks, or when

disclosure is required by law.

3.2.6 Fair and equitable treatment

Allbusiness dealings on behalf of the financial institution with current andpotential customers, with other members of the staff, and with all those who may

have cause to rely upon the financial institution, should be conducted fairly andequitably, without granting favored terms. Staff and Directors must not be

influenced by friendship or association, either in meeting a customers

requirements, or in recommending what needs to be carried out. Such decisions

must be strictly made on an arms-length basis. All preferential transactions withinsiders or related parties should be avoided. If transacted, such dealings should

be in full compliance with the laws, rules, and regulations and must be based on

normal business criteria, and fully documented.

3.3 MONITORING DEVICES

To ensure adherence to the Code of Ethics, the Board of Directors of eachfinancial institution must take positive steps to establish as soon as possible some

effective monitoring devices. The Board should at least:-

(a) require all Directors and employees (existing and upon appointment in thecase of new employees) to sign a declaration on their observance of the

ethical standards; and



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(b) assign responsibility to the Chief Executives to ensure compliance withthese standards on a day-to-day basis, and to handle general enquiriesfrom staff on matters relating to the code of conduct. Breaches observed

should be reported and a centralized record, under the control of the

personnel manager and disciplinary committee of the institution, should be

available for inspection by the RMA.

(c) In the case of a serious breach such as fraud or embezzlement, the matter

should be reported immediately to the RMA and to the Board of Directors.

3.4 CODE OF ETHICS (Minimum Requirements)15

The above regulations are meant to serve as a guide for the promotion of properethical standards, and sound and prudent business practices amongst financial

institutions. Such a code of ethics should not, however, restrict or replace the

mature judgment of staff in conducting their day-to-day business. Where there is

doubt over matters relating to the code of ethics, staff should seek guidance from

their respective heads of departments, who may, if necessary, seek guidance fromthe Chief Executive, or the Board of Directors or from the RMA.

3.5 FINANCIAL INSTITUTIONS CODE OF ETHICS16

Every financial institution is required to adopt, at the least, the above regulations

as their code of ethics, more comprehensive in-house rules which require ethicalstandards not below that required by these regulations. A copy of the in-house

rules duly approved by the Board of Directors should be submitted to the

Financial Regulation and Supervision Department (FRSD), RMA on a yearlybasis.

3.6 NO RECRUITMENT OF EMPLOYEES TERMINATED FROM SERVICES

OF OTHER FINANCIAL INSTITUTIONS/OTHER AGENCIES

An employee terminated by any other financial institution or other agencies,

based on the grounds of embezzlement of fund or fraud, should not be recruited inany financial institution. Therefore, for the purposes of recruitment, it is

mandatory that a clearance certificate of no objection or reference be sought from

the previous employer.

15Amended on July 20, 200916Amended on July 20, 2009


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SECTION - 4

REGULATIONS ON SHARES TRADING

4.1 INTRODUCTION

4.1.1 The establishment of brokerage firms as subsidiary companies of the financial

institutions could give rise to practices that may result in conflict of interest. As

investment advisers and underwriters, the financial institutions and their staffcould possibly obtain undue advantage to gain from shares trading businesses,

especially when dealing in shares of companies in which they have privileged

information. Such a situation could result in the abuse of general trading practices

and create public concern. Therefore, in order to avoid any conflict of interest and

to allay fears of unethical practices, it would be expedient for the financialinstitutions to strengthen their internal control procedures. Certain codes of

conduct should be established and disciplinary actions taken on staff who abusetheir positions.

4.1.2 The working relationship between the parent institution and its stock-brokingsubsidiary must be well established. A satisfactory and effective Fire Wall

should exist between the stock-broking firm and its parent institution. Trading

should always be on an arms-length basis and not on biased or favorable terms.

4.1.3 A financial institution may not deal in the securities of any company listed orpending listing on the stock exchange at any time when any of its staff is in

possession of insider information, unless the staff is not involved in the decision

to trade in those securities and the group has arrangements to ensure that such

information is not communicated to the person making the decision to trade and itis not so communicated.

4.1.4 Staff and Directors shall not deal in the securities of any company listed orpending listing on the stock exchange at any time when he/she is in possession of

information, obtained as a result of his employment by, or his connection with the

financial institution which is generally not available to shareholders of thatcompany and the public, and which, if it were so available, would likely bring

about a material change in the market price of the shares or other securities of the

company concerned.

4.1.5 Insider dealing by a financial institution (or its staff) has pervasive adverse effects

on its integrity and credibility, and therefore viewed as very serious. Financial

institutions may, therefore, establish comprehensive in-house rules which shouldrequire a minimum standard of conduct.


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4.2 In terms of Article 46 of the Financial Institutions Act,a financial institution

must not grant credit, give any guarantee or incur any other liability, against thesecurity of:

(a) its own shares, the shares of a subsidiary, or the shares of a parent company;

or(b)the shares of a subsidiary of a parent company.

4.3 LOANS AGAINST SHARES OR LOANS FOR THE PURCHASE OF

SHARES

No financial institution shall grant loan against shares or for the purchase of

shares exceeding 50 % of the existing market price or offer price, whichever islower at that point of time.

4.4 INFORMATION ON SIGNIFICANT OWNER OF LISTED COMPANIES17

The depository under the Royal Securities Exchange of Bhutan shall inform and

submit to the Financial Regulation and Supervision Department of RoyalMonetary Authority of Bhutan, the list of all the significant owners of the listed

companies on a monthly basis.

4.5 COMPLIANCE REQUIREMENTS FOR THE ROYAL SECURITIES

EXCHANGE OF BHUTAN18

The Royal Securities Exchange of Bhutan shall comply with the following

regulation:-

(a)Securities Exchange Regulation 1993(b)Rules Governing the Official Listing of the Securities(c)Rules of the Exchange

4.6 COMPLIANCE REQUIREMENT FOR BROKERAGE FIRMS19

All Brokerage firms and their staff shall comply with the requirements of the

Control of Brokers Regulations 1993.


18Amended on March 29, 201019Amended on March 29, 2010


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SECTION - 5

REGULATIONS ON SUBMISSION OF ANNUAL ACCOUNTS

5.1 INTRODUCTION

5.1.1 As takers and custodians of public funds, financial institutions have a

responsibility for the prompt finalization and publication of their annual financial

results. A delay in the publication of final accounts usually indicates poormanagement of the financial institution concerned, which would reduce public

confidence in the management of the institution.

Part VIII, Article 51 of the Financial Institutions Act provides, inter alia, that:-

5.1.2 The form and the content of the annual balance sheet and profit and loss account

of a licensed financial institution should be approved by the RMA;

5.1.3 Every licensed financial institution is required, within three months after the

close of each financial year to prepare a balance sheet and profit and loss accountas of the last working day of that year.

5.1.4 All financial institutions must send to the RMA the auditor initialed balance sheet,profit and loss account and external auditors report described in Section 1 (b) of

Article 52 of the Financial Institutions Act. The submission of these final

accounts to the RMA shall be within 14 days of its preparation by the statutoryauditors. In addition, the financial institutions shall also submit two copies of their

annual report to the Financial Regulation and Supervision Department of theRMA.

5.1.5 In terms of Article 53, Part VIII of the Financial Institutions Act, a licensed

financial institution must publish its annual audited accounts in a nationalnewspaper. Further, a financial institution must also publish its un-audited

accounts in a national newspaper on a half-yearly basis.

5.1.6 If a financial institution should have problems in finalizing its draft accounts early

due to differences in opinion between its management and external auditors over

income recognition and provisioning for bad and doubtful debts, the institutionconcerned and its external auditors should discuss and resolve these matters with

the Financial Regulation and Supervision Department of the RMA to avoid delay

in finalizing the accounts. Under such situation, it is mandatory for the externalauditors and the financial institution to meet with the RMA examining officers to

finalize the necessary provisions. If the auditors do not agree with the

management, they may submit the draft accounts with a subject to proviso on

the disputed items.


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5.1.7 Financial institutions should ensure that the audit of their accounts by the external

auditors is promptly carried out after the close of each financial year.


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SECTION - 6

REGULATIONS ON CAPITAL REQUIREMENT

6.1 INTRODUCTION

6.1.1 Capital

Capital serves as a reserve against unexpected losses and is the foundation of asound financial system. The maintenance of adequate capital is most often the

principal source of public confidence in any financial institution. Capital provides

confidence and protection to depositors, creditors, the central bank, and ultimatelyto the government. Therefore, it is important to establish a legal framework

governing the minimum capital requirements, as well as minimum capital

standards to be observed by the financial institutions.

These regulations shall determine the minimum level, the structure, and the ratiosof the capital base of a financial institution, to its balance-sheet assets and off

balance-sheet items.

6.2 MINIMUM CAPITAL REQUIREMENT20

(i) The minimum paid-up capital for different types of financial institutions shall be

as follows:-

(a) Bank - Nu.300 million.

(b) Non-bank financial institution - Nu.200 million.

(c) Non-bank finance company - Nu.100 million.

(ii) No license shall be issued to a financial institution until the paid-up portion of its

subscribed capital amounts to the minimum prescribed level, indicated above.

(iii) All existing banks and non-bank financial institutions shall raise their paid-up

capital to the minimum prescribed amount indicated in (i) (a) and (b) above latest

by January 1, 2009.

(iv)21

Except for those financial institutions which are exempted by the RMA in

consideration of the special circumstances relating to the nature of its business allfinancial institutions shall be a public limited company registered under Companies

Act 2000 and listed with any stock exchange in Bhutan.

20Amended on March 31, 200821Amended on March 29, 2010


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6.4 CAPITAL ADEQUACY RATIOS

(a) Every financial institution shall maintain a Capital Adequacy Ratio (CAR) of not

less than 10%22

. For this purpose, CAR shall be computed as the ratio of the

institutions capital fund to its risk weighted assets, plus risk weighted off-balance

sheet items.(b) Every financial institution shall maintain a core capital adequacy ratio of not less

than 5%. For this purpose, the core capital adequacy ratio shall be computed as

the ratio of the institutions total Tier 1 capital to its risk weighted assets, plus riskweighted off-balance sheet items.

(c) The capital adequacy ratios shall be observed by each financial institution and thefinancial institutions group as a whole.

6.4.1 Limits on the Use of Different Forms of Capital for Capital Adequacy RatioPurposes

For purposes of computing capital adequacy ratios:-

(a) Total of subordinated term debts of a financial institution shall not exceed 50% of

the Tier 1 capital.

(b) Total Tier 2 capital shall be included in the capital fund, only up to the extent of

100% of the total Tier 1 capital.

6.5 ADJUSTMENT OF CAPITAL

(i) When a financial institution fails to meet any of the capital adequacy ratios set out

in 6.4 above, it shall immediately notify the RMA of the circumstance and draw

up a rehabilitation program, including deadlines for restoring the capital adequacy

ratio. During the rehabilitation program, the financial institution is prohibitedfrom paying out dividends to its shareholders, and must allocate the full amount

of its profit to the statutory reserves.

(ii) In case of failure by the financial institution to abide with the rehabilitation

program or to meet any deadlines, it shall be liable to such measures and penalties

as may be imposed by the RMA, under Article 58 of the Financial InstitutionsAct.

6.6 RISK WEIGHTING

For the purpose of these regulations, both the balance sheet items and off-balance

sheet items shall be assigned risk weights as follows:-

22Amended on August 16, 2007


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(i) Zero Risk-Weighted Assets

(a) Cash in hand;

(b) Precious metals;

(c) Balances with the RMA (Current Deposits and CRR);

(d) Bills issued by the RMA;

(e) Bills and Bonds issued or guaranteed by the Government;

(f) Reserves Repurchased by the RMA;

(g) Loans & Overdrafts secured by cash deposits with banks in Bhutan; and

(h) Claims and guarantees, including fixed interest securities, with a

remaining maturity of not more than one year, issued by government orcentral banks of Zone Acountries.

(ii) 20% Risk-Weighted Assets

(a) Claims on financial institutions in Bhutan

(b) Claims on financial institutions incorporated in Zone Acountries

(c) Claims and guarantees, including fixed interest securities, with remaining

maturities of more than one year, issued by governments or central banks

of Zone Acountries.

(d) Claims and guarantees, including fixed interest securities, with a

remaining maturity of not more than one year, issued by governments and

central banks of Zone Bcountries.

(iii) 50% Risk-Weighted Assets

(a) Claims and guarantees, including fixed interest securities, with remaining

maturities of more than one year, issued by governments and central banks

of Zone Bcountries.

(b) Claims with remaining maturity of not more than one year, on financial

institutions incorporated in Zone B countries, including deposits inIndia.

(iv) 100%Risk- Weighted Assets

(a) Equity investments (net of specific provisions);


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(b) Investments in real estate (net of specific provisions);

(c) Term loans and overdrafts (net of specific and general provisions);

(d) Claims* with remaining maturities of more than 1 year, on financialinstitutions incorporated in Zone B countries (including India);

(e) Fixed Assets; and

(f) Other Assets.

(v) Off-balance sheet items (net of margin money)Net of margin money, all off-balance sheet items shall be assigned 100 percent

risk weighting.

*NB:- Claims include deposits, term loans and overdrafts

6.7 ZONES

For the purposes of these regulations, countries are divided into two zones as

follows:-

(i) Zone A CountriesThe term Zone A covers full members of the Organization for Economic Co-

operation and Development (OECD) and those countries which have concludedspecial lending arrangements with the IMF associated with the IMFs General

Agreement to Borrow (GAB), provided they have not rescheduled their externalsovereign debt, to official or private sector creditors, in the previous five years.

Zone A countries now comprise : Australia, Austria, Belgium, Canada, Czech

Republic, Denmark, Finland, France, Germany, Greece, Hungary, Iceland,Ireland, Italy, Japan, Korea, Luxembourg, Mexico, Netherlands, New Zealand,

Norway, Poland, Portugal, Saudi Arabia, Spain, Sweden, Switzerland, Turkey,

United Kingdom and United States.

(ii) Zone B Countries

All countries not included in Zone A are in Zone B.

6.8 REPORTING OF CAPITAL ADEQUACY

6.8.1 Report on the Risk Component and Capital Adequacy

(a) The RMA will prescribe the forms (Form FIS-Q7) and issue mandatory

instructions on the manner of drawing up and submitting the report on the riskcomponents and the capital adequacy by the institutions.


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(b) Based on the balance sheet for the last day of each quarter, every financial

institution shall draw up a report on the risk component and its capital adequacyratio. The report must be submitted to the RMA before the end of the first month

following the quarter.

(c) Each financial institution shall draw up and submit to the RMA an annual reporton the risk component and its capital adequacy ratio. The report must be

submitted within the first three months following the end of a financial year.

6.9 ADDITIONAL INFORMATION

The RMA may require from financial institutions additional information and

analytical breakdowns on each item on the risk component and capital adequacy,with each determinant of accounting included.

6.10 CONTROL OVER THE VERACITY OF DATA

The RMA may conduct an examination on the veracity of data in the reports and

for compliance with the rules for establishment of the risk weighted assets. Thismay include on-site inspections and comparison between the data in the reportand the accounts of the financial institutions. The external auditors will conduct a

verification, reflect in the report and give an opinion on the correct weighting of

the risk weighted assets. Furthermore, the auditors opinion shall contain anassessment of the capital adequacy of the financial institution.


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SECTION - 7

REGULATIONS ON LIQUIDITY MANAGEMENT

7.1 LIQUIDITY AND ITS RATIONALE

7.1.1 Liquidity is defined as a financial institutions ability to meet anticipated and

contingent obligations as and when they fall due. A financial institution must,

under any circumstances, maintain sufficient liquidity to fulfill all its contractualobligations in the normal course of business. A financial institution may have

various obligations:-

(a) obligation to pay deposits or borrowings;

(b) obligation to provide committed funds; and

(c) obligation to make other payments such as cash flows in respect of off-balance sheet instruments, interest payments and other expenses.

7.1.2 A financial institution can meet such obligations in a number of ways:

(a) by holding sufficient immediately available cash or easily marketable

securities;

(b) by securing an appropriately matching profile of cash flows from maturing

assets and liabilities; and

(c) by borrowing.

7.1.3 Financial institutions are reluctant to hold a large stock of immediately available

cash or marketable securities as these generate comparatively low or no yields.They, therefore, depend on future cash flows and their ability to raise funds in the

market as and when the need arises. Thus, it is essential that a financial institution

has ample funding capacity. This, in turn, depends on a variety of factorsincluding strong liquidity management, market perception, earnings and asset

quality.

7.2 REGULATIONS FOR LIQUIDITY MANAGEMENT

7.2.1 The management of a financial institutions liquidity should be based on future

financial inflows and outflows (financial flows). Planning for financial flows isdependent on two fundamental conditions:-

(a) an adequate information system; and

(b) prompt recording of all transactions in books of accounts.


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7.2.2 Within its information system, a financial institution is obliged to analyze itsassets, liabilities, and off-balance sheet assets and liabilities according to:

(a) remaining period to maturity of its fixed term assets, liabilities, off-

balance sheet assets and liabilities;

(b) anticipated developments in its fixed term liabilities, such as the probable

volume of deposits rolled over by depositors on maturity date;

(c) experience with depositor behavior in respect of current and savings

deposits, and time deposits under specific conditions;

(d) degree of liquidity of assets with respect to:

their immediate availability to cover fund outflows;

the possibility of their transfer into funds with the RMA;

their tradability on the financial market whose size will allow the saleof a required volume of assets for a price corresponding to their market

value, or for a price higher or equal to their book value;

the possibility of a decrease in the value of the asset, concurrent with adecrease of relevant liabilities (reserve requirements)

(e) deposits of individual depositors or groups of connected depositors (see

below);*

(f) type and degree of liability of off-balance sheet items issued or received

by the financial institution;

(g) currencies in which assets, liabilities, and off-balance sheet items areexpressed;

(h) legal status of a depositor in the country where he resides and according tothe financial institution instrument used.

* For the purposes of this Regulation, a group of connected depositors means twoor more depositors (natural or legal persons), to whom a financial institution hasa commitment following from deposits received, and who are mutually associated

through either one of the depositors exercising control either directly or indirectly

over the other depositors.


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7.3 METHODS OF ACHIEVING LIQUIDITY

In order to secure liquidity the financial institution shall concentrate its activitiesparticularly on:

(a) financing firstly from stable sources within agreed terms;

(b) the diversification of sources of financing according to maturity, financial

instruments and clientele;

(c) introducing organizational measures directed at effective liquidity

management (e.g. entrusting a particular employee with liquidity

management, introducing effective control and internal audit of thefinancial institutions liquid position);

(d) degree of the financial institutions integration in the money market and

trading in the market;

(e) regular formulation of its liquidity policy together with planning to ensure

sufficient resources for its business plans and to reduce any structuralimbalance of its assets and liabilities following from differences between

agreed and actual maturity dates;

(f) holding a sufficient volume of quick assets with respect to the repayment

of short term deposits.(For the purpose, quick assets are cash; gold and

precious metals; balances with the RMA (excluding statutory reserves);

demand deposits with banks in Bhutan and India (for CBs) and al demand

deposits (for NBFIs); government and government guarantee securities;

RMA securities; and time deposits with a remaining period to maturity not

exceeding one year held with commercial banks in Bhutan (for NBFIs);23

(g) regular compiling and updating of a contingency plan for unusual eventswhich threaten the financial institutions liquidity. This will comprise the

designation of responsible employees, identification and value (volume) of

assets to promote and secure the financial institutions liquidity;

(h) each financial institution should appoint an Asset Liability Management

Committee (ALM Committee) which will be responsible for formulatingrecommendations and implementing the financial institutions liquidity

policy;

(i) the financial institution shall report to the RMA, the body responsible for

supervising and controlling implementation of the approved liquidity

policy.

23Amended on July 20, 2009


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7.4 MINIMUM REQUIREMENTS AND REPORTING

7.4.1 Cash Reserve RatioEvery bank is statutorily required to maintain a Cash Reserve Ratio (CRR) in the

ratio as may be prescribed by the RMA from time to time. The CRR must bemaintained in the form of a current account deposit with the RMA.

7.4.2 Statutory Liquidity Requirement Ratio24

Every financial institution shall, at all times, maintain minimum liquidity in the

form of quick assets, in a ratio not less than that set out below:-

(a) Banks - 20% of total liabilities, excluding

capital fund and liabilities to the

RMA

(b) Non-bank financial institutions - 10% of total liabilities, excludingcapital fund and liabilities to the

RMA

7.4.3 Reporting requirements25Every financial institution is required to submit to the Financial Regulation andSupervision Department, RMA, a monthly Liquidity Return in FormM5 - which

sets out the maturity mismatch profile of the institution according to time bands of

the remaining period to maturity of its assets and liabilities.

7.5 THE MATURITY MISMATCH APPROACH

7.5.1 The maturity mismatch approach measures a financial institutions liquidity by

assessing the mismatch between its assets and liabilities within different time

bands on a maturity ladder. The extent of the difference between the maturities ofassets and liabilities is termed a mismatch. Assets and liabilities are slotted into

time bands according to their maturity on a worst-case view i.e. assets (inflows)

are put in at their latest maturity and liabilities (outflows) at their earliest maturity.This approach is adopted, because, what is needed is an assessment of a financial

institutions liquidity in a situation when funding sources are unwilling to lend

and depositors withdraw their money.

7.5.2 A net mismatch figure is obtained by subtracting liabilities from assets in each

time band. Mismatches are then measured on a net cumulative basis. This isachieved by accumulating the net positions in each successive time band to arrive

at a net cumulative mismatch figure.



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7.5.3 A financial institutions liquidity position shall be assessed by the RMA by means

of the net cumulative mismatch position expressed as a percentage of total depositliabilities. Total deposit liabilities (the total of the deposits/borrowings) held by

the financial institution is used because it represents a relatively stable

approximation of the total external (or withdrawable) funding of the financial

institution.

7.5.426

The RMA will set benchmarksfor the maximum percentage for net cumulative

mismatches as a percentage of total deposit liabilities. These are known asmismatch benchmarksand prevent financial institutions from operating with too

large a negative mismatch, and thereby, running an excessive risk of not being

able to raise sufficient funds to cover the mismatch at short notice. Thesebenchmarks will be set for maximum mismatches only for the time bands of

overnight -8 days, overnight -1 month and overnight 3 months. Mismatch

regulations are not usually set for the longer time bands as in most cases, over a

longer time period, financial institutions will have a greater opportunity to raise

funds.

7.5.5 The maturity ladder serves to compare the volume of assets and liabilities of thesame maturity across a number of time bands. The time bands included in the

maturity mismatch ladder on the reporting forms are:

Overnight;

spot


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7.6.2 Assets

(i) Assets are generally included in the maturity ladder according to their final

maturity net of provisions. Assets known to be of doubtful value are excluded

from the maturity ladder and treated on a case-by-case basis. Where assets have

been pledged as collateral and are therefore no longer available to the financial

institution to meet obligations, they should be excluded from the maturity ladder,as they are no longer available to provide the financial institution with liquidity.

(ii) In respect of overdue assets, if on any reporting date, an asset, or part of it, haspassed the due date for repayment by 30 days or more, then the amount or

principal which is in arrears should be entered in the overdue column. Assets

having passed the due date by less than 30 days should be entered under nextday. Only that part of a loan or other asset actually overdue, and not any un-

matured installments, should be reported in the overdue column unless the whole

of the loan or asset has been formally declared to be in default within the terms of

the contract.

(iii) Amounts overdue in respect of secured loans should be included unless the

collateral has been realized. Amounts overdue without regard to whether aspecific provision has been made should be included. Amounts written off,

however, should not be included in any part of the form.

7.7 FACTORS CONSIDERED IN SETTING BENCHMARKS

Mismatch benchmarks will be set for each financial institution for the spot< 1

week and spot


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(f) the dependence on drawings of standby lines in order to maintain adequate

liquidity, and in particular the possibility of calls for early repayment onlines which have already been drawn;

(g) the impact of other business such as off balance sheet obligations.

(ii) Qualitative Factors

In setting mismatch benchmarks consideration should also be given to certain

qualitative factors:

(a) the asset profile;

(b) the quality of management information systems;

(c) the market reputation, general ability of management and the particularskills of the treasury area;

(d) the ability and willingness of the parent/ head office to provide liquidity;

(e) the financial institutions standing and reputation in the market.


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SECTION - 8

REGULATIONS ON CREDIT CONCENTRATION

8.1 CREDIT CONCENTRATION AND ITS RATIONALE

8.1.1 The excessive concentration of risk exposure to a single borrower, or to a group

of borrowers and to their related interests, industry or economic sector, country or

activity, places a financial institution in a vulnerable position, as the businessfailure of the borrower, or unfavorable developments in the sector or country

could have an adverse effect on the financial position of the institution itself.Historically, financial institutions have been known to have failed because of

excessive lending to a group of borrowers, over-exposure to markets such as real-

estate or stocks, or engaging in excessive speculative activities arising from highforeign exchange exposure, or maturity and interest-rate mismatches. These

excessive exposures are normally generated by either technical misjudgment of

sudden changes in the market, or as a result of mismanagement. Moreover,restricting aggregate credit to large borrowers may also have a beneficial effect inmaking credit available to a broader group of borrowers.

8.1.2 It is therefore, necessary that within the regulatory framework prescribed by theRMA, financial institutions should clearly define their lending policies in respect

of limits and procedures for the granting of large credit facilities to borrowers.

Credit risk must be contained by ensuring that a financial institutions exposure isdiversified, e.g. by customer, geographical spread or economic sector.

Concentrations will also arise through the specialization of financial institutions

for reasons of competitive advantage and expertise. For this reason, safeguarding

against excessive concentration is one of the most important components in anyfinancial system. The primary purpose of this regulation is to allocate and limit

the loss, which a financial institution may suffer from concentration of exposures.

8.1.3 Therefore, the purpose of the regulations in this Section are to define the

permissible limits of a financial institutions exposure to an individual borrower,

or to a group of borrowers and their related interests. The regulations are not onlydesigned to restrict the concentration of risk to a few borrowers, but the

underlying philosophy or intention is to diversify risk among the institutions vis-

-vis their exposure to a few borrowers. Financial institutions could possiblyconsider large loans to big borrowers through consortium financing, or syndicated

loans to reduce their respective exposures. Alternatively, a financial institutioncould also increase its capital base, and the size of its total loan portfolio to enable

it to increase the size of its loan to large borrowers.


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8.2 RISK EXPOSURE

8.2.1 Risk exposure is the amount at risk arising from the aggregate of the financial

institutions business, whether conducted on or off-balance sheet, the realization

of which generates an unconditional claim in favor of the financial institution.

These will comprise claims on a counter party including actual claims andpotential claims which would arise from the drawing down in full or un-drawn

advised facilities (whether revocable, irrevocable, conditional or unconditional),

which the financial institution has committed itself to provide, and claims whichthe financial institution has committed itself to purchase or underwrite.

8.3 SINGLE BORROWER

8.3.1 For purpose of these regulations, single borrower is defined as:

(a) an individual, his/her spouse, and persons who are economically

dependent on the individual to a substantial degree; and

(b) persons with common business or financial interests, whether incorporatedor not, including:

(i) a partnership and its members;

(ii) an enterprise and participants in the enterprise who borrow for that

enterprise;

(iii) a group of enterprises or companies with common ownership;

(iv) a company and its majority owned subsidiaries.

8.3.2 For the purpose of this regulation, single largest borrower shall not includerelated party of the FIs as defined under Section 2.2 and 2.5.1

8.4 LIMIT ON CREDIT TO A SINGLE BORROWER

8.4.1 No financial institution shall extend credit (funded and non-funded) to a single

borrower exceeding 30 percent of its capital fund. For this purpose, capital fundshall consist of that amount based on previous years final and audited balance

sheet. Credit Exposure to a single borrower may exceed the exposure norm of 30

percent of the financial institutions capital funds by an additional 10 percent (i.e.up to 40 percent) provided the additional credit exposure is on account of

infrastructure27

. The limit on credit exposure to a single borrower specified above

shall not apply in the following cases:-


The lists of items included under infrastructure sector are furnished in Annexure II.


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(a) inter-bank exposures with a maturity of one year or less;

(b) exposures fully covered by cash collateral;

(c) exposures covered by government guarantees;

(d) exposures to governments and the central banks.

8.4.2 Loans and advances extended to borrowers, defined as a single borrower, shall becombined and subject to the overall credit limit of 30% of capital fund and 40%

of capital fund on account of infrastructure lending. Where an individual or a

group of individuals defined as a single borrower, holds 50% or more of theequity of a company, loans and advances to that company shall be combined with

loans and advances to the individual or group of individuals to the extent of the

individual or groups ownership of the company.

8.4.3 Exposure to a single borrower shall be determined on the following basis:

(a) Term loans - the outstanding balance (principle + interest)(b) Overdrafts & working capital advances - thesanctioned limit, or the

outstanding balance, whichever is greater.

(c ) Off-balance sheet items - the off-balance sheet amount less margin money

8.5 LIMIT ON CREDIT TO TEN LARGEST BORROWERS

The aggregate of loans and advances granted by a financial institution to its tenlargest borrowers, including economically dependent persons, shall not at any

time, exceed 30% of its total loan portfolio. For the purpose of this regulation,economically dependent person shall have the same meaning as a single borrower.

The determination of loan aggregates for the ten largest borrowers shall be based

on 8.4.3 above.

8.6 CONSORTIUM FINANCING28

Notwithstanding any limits provided under Section 2.3, 8.4 and 8.5, consortium

financing (CF) of large value loans by two or more FIs may be permitted in line

with the following criteria:

(a) require a lead financer who shall maintain all the original records and filespertaining to the CF loan account.

(b)the amount of loans sanctioned shall not, in any way, exceed the 30%prudent limit prescribed by the RMA. However, if the quantum of loan is

extremely high, and it exceeds the 30% limit of all the financialinstitutions, the financing of the large borrower may be carried out in



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proportion to the respective capital funds of the financial institutions, but

not exceeding 50% of the capital fund of the financial institution.

(c) In case of financing to any related party by the FI under consortiumfinancing, the FI shall not be the lead financer.

8.7 REPORTING OF LARGE EXPOSURES

8.7.1 By the last day of the month following the end of each quarter, every financial

institution shall submit to the RMA:-

(a) a statement of its ten largest exposuresin Form FIS-Q2, together with a

list of all exposures exceeding 10% of capital fund;

(b) a statement of large loans and advances by sector inForm FIS-Q3.

8.7.2 The Financial Regulation and Supervision Department of the RMA may require

additional information in regard to each exposure and/or conduct examinations onthe veracity of reports.


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SECTION - 9

REGULATIONS ON ASSET CLASSIFICATION AND PROVISIONING

9.1 INTRODUCTION

9.1.1 A realistic valuation of assets and prudent recognition of income and expense are

critical factors in evaluating the financial condition and performance of financialinstitutions. Since most financial assets are loans and advances, the process of

assessing the quality of credit and its impact on the financial institutions

condition is critical. Financial institutions must therefore exert due care anddiligence in maintaining stringent monitoring of loans and advances, both during

approval and through their existence. Charging-off irrecoverable assets and

provisioning against non-performing assets (NPA) must be done without regard to

the potential impact on the Profit and Loss account of a particular year or period.

Credit extensions, loan restructuring and simple renewals of problematic loanswill not change the treatment or aging of past due loans unless new effective

repayment guarantees are brought in. Financial institutions will therefore have toinstitute a proper monitoring and control system of assessing these credit risks and

then classifying the loans into their appropriate categories.

The regulation in this Section shall determine the criteria and manner of

evaluating credit exposures of financial institutions; the conditions, amounts and

procedures for the allocation of provisions to cover the risk related thereto; andthe supervision exercised by the RMA on the compliance with these requirements.

9.2 CREDIT POLICIES AND PROCEDURES, AND CREDIT COMMITTEES

9.2.1 Each financial institution shall organize a Credit Committee and adopt internal

policies and procedures for its credit activities and prepare a credit Manual.

9.2.2 Each financial institution shall also establish a Credit Review Unit (CRU) as a

specialized internal body for monitoring, assessing, classification andprovisioning of credit exposures.

29

9.2.3 The structure and powers of the Credit Review Unit, as well as the regular CreditCommittee, shall be specified in the Credit Manual and Procedures. Persons

directly responsible for the extension of the credits and for maintaining relations

with borrowers shall not be eligible for participation in the Credit Review Unit.

9.2.4 The Credit Manual and Procedures shall be submitted to the Financial Regulation

and Supervision Department of the RMA30

on a yearly basis.



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9.3 GENERAL REQUIREMENTS

9.3.1 Financial institutions shall assess, classify and report their credit exposures at

least on a quarterly basis in accordance with the principles and criteria provided

for in this regulation.

9.3.2 Where a financial institution has more than one exposure to a single borrower

under various account titles, if one or more of the accounts should experiencerepayment problems and the defaulted amount of these problematic accounts are

equal to or more than 50% of the total exposure, then the total exposure shall be

classified into the classification category with the highest risk level exposure.However, if the defaulted amount is less than 50% of the total exposure, then

under such a situation, the accounts may be classified where they actually need to

be categorized.

9.3.3 Financial institutions shal

Documents

28Prudential Regulations 2002