Monday, May 27, 2013

Governance in Banks is hollow

Corporate Governance in Banks?
Reserve Bank of India recently reiterated the Risk Based Supervision would be pursued vigorously in the backdrop of Basel III. All Bank Boards have put in place Risk management committee and Audit Committee as a regulatory compliance measure. Now most District Central Cooperative banks and the State Cooperative banks under the supervision of NABARD are also expected to fall in line with such regulatory compliance measures. Apparently it looks as though that the financial sector in India is way ahead of several emerging economies in Basel III implementation management.
Go deep into the functioning of Boards: one realizes that the measures are hollow. The seriousness of these measures fall flat when one realizes that the Supervisor who does annual audit, namely, NABARD sits on the Boards of the State Cooperative Banks and so does the RBI representative sits on the Boards of all public sector banks. In respect of one-time-settlements as out-of-the-court compromise settlements in respect of the non-performing loans, there would seem to be regulatory arbitrage.
The difference between the market value of realizable securities and the loan outstanding plus interest due till the date of settlement, could be negligible. But because of the delays in the judicial process, a series of discussions take place to compromise the loan amount taking into account the ability of the NPA account holder to pay up the amount immediately after considering all options, so that the bank’s balance sheet becomes cleaner and capital provisioning gets humbled. Here lies the catch: the assessment of the CEO in regard to the ability of the enterprise to honor the commitment after providing for all the guarantees and counter guarantees and other collaterals depends on the support that he or she gets from the Board and the willingness of the Board to write off the difference between the outstanding dues and the compromised amount. In several cases such gap runs into huge amount – millions of rupees.
Illustratively, the outstanding loan amount is INR40mn. The easily realizable market value of collaterals and guarantee is INR 110mn. But the CEO convinces the Board: the Court is likely to take a long time to settle this and therefore a compromise is desirable as it would save the bank the ordeal of delay, court expenses, advocate-briefings etc. etc. the compromise amount arrived at is INR6mn, meaning thereby that the Board has to write off INR 34mn. The Board signs off the proposal and accords approval for this write-off. The supervisor sitting on the Board is a party to this transaction. In several cases, the actual amount that the borrower settles is a few notches up over the six million rupees. The difference between the actual settled amount and that appearing in the books as long as it is far below the outstanding amount, the borrower is comfortable. The sharing of this booty between the CEO and the Board could be anybody’s guess. Such cases are more in cooperative banks and in respect of medium and large enterprises as well in corporate loans of commercial banks. It is not unlikely that somebody accuses me of a wild and senseless allegation against responsible Boards. But if one goes through the OTS settlements that were cleared by the State Cooperative Banks’ Boards, within a few months after the elections to the Boards are announced, the allegations have a chance to stand the test.
Since the supervisors/regulators are on the Boards, even if some intelligent auditors bring to light such losses the remarks have the chance of being either ignored or expunged lest the RBI or GoI can pull them up for being party to the resolution that resulted in the loss!!

The best way to arrest these types of transactions is to strengthen the corporate governance by the regulators/supervisors at once disassociating themselves from being on the Boards of all categories o f Banks. Will this ever happen? The non-executive directors abound in Indian Boards but they end up as spectators and rubberstamp signatories.