Little Cheer for Bank Nationalization

INDIA NEEDS TO DO SOMETHING MORE…

CRISIS OR NO CRISIS

                                                                                   

The Day of Bank Nationalization in India passed off on Sunday. Smiles were kept years behind. None talk of village adoption scheme; no Chairman would go to a village these days to see how their rural branches are helping the farmers or the MSME is financed. No pride in ownership. No regret for bad governance.

But for a full page pull-out by the All India Bank Employees’ Association on the 20^th July, 2020, who remembers the Nationalization Day? Neither the employees, nor the disappointed customers that include even the Banks’ own pensioners, nor those seeking credit from them recall the Day. People are only alert on wearing masks and spiriting their palms before handling the currency received from outsiders. Everyone cries wolf on the ever-bulging non-performing assets. The only solid reform that we boast of is the Insolvency and Bankruptcy Code. Job creation is hurt badly in the organized sector with near-65% of MSMEs shutting their windows in pandemic. Their markets are yet to revive.

Banks in UK, Iceland, and even the US resorted to the most criticized and least preferred route of nationalization of banks, when they confronted a crisis. The then OBAMA initiative that received positive response of stock markets since the announcement of Toxic Loan basket takeover under a joint Government-Private Fund, was however inadequate to retrofit the lost confidence in the financial system. 

The revival of ‘protectionist’ actions would seem to be asserting more in finance than in trade.  While the regulators of G-20 would be meeting at the shortly, global regulatory regime has serious limitations and they should be realigned with domestic regulations that have compulsive cultural characteristics. 

Events so far have proved beyond doubt that a global regulatory regime would not be able to provide appropriate solutions to the type of recession that had set in due to pandemic. No prediction as to when it would end. Annual Balance Sheets for 2020 are waiting for finalization in several institutions. Basel III may have introduced a modicum of discipline and uniformity in risk discipline among Banks globally. Several regulators sought more flexibility. It is important for India to realize its distinction in the emerging economic scenario and how necessary it is to turn the head on the screws.

At the commencement of Covid attack, India did well and even till now, we do not find people scrambling for food because farmer and rural India stood by the nation.  The biggest blunder of the system is more announcements than actions and imperfect monitoring and undependable statistics. All the rating agencies, IMF and World Bank kept the ratings low and estimated growth of 42% in 2021. Opening the economy with lot of courage has not been taken too kindly by Corona that has been surging every day crossing the 10lakh persons. India took the 4th rank in the world in Corona affected nations.

Second, we have the key sectors like Steel, Zinc, other Metals and Coal as also the transportation system largely in the public sector. We entered the Commodity markets and derivative markets in our anxiety to mix with the globe. WTO is almost nearing collapse with most countries choosing to adopt policies that secure their own nations and people, not caring so much for the global discipline. 

Third, there was no demand recession of the magnitude that the other countries in the globe faced.  Still the rural areas where still 65 percent of our population lives, drive the demand growth.  Having said that some facts that can be hardly ignored: there is a steep decline in job growth; steep declines have also set in the private sector trumped up by the global recession; the urban and metro retail chains took a severe beating; the real estate and housing boom that irrationally stepped up land values across the country took the first heat-stroke and with them, the dependent MSME sector that is seen as the engine of growth.

Fourth, Banks that lent heavily for the retail sector and real estate sector started facing the continuous decline in their performing assets.  They lost confidence in the resurgence of the demand and the productive capacities of the manufacturing sector.  Most public sector banks even, refused to go with the RBI to pump credit. 

Atma Nirbhar Bharat Abhiyan, the stimuli announced to combat Covid-19, injecting more than Rs.20lakh liquidity, still face risk aversion from the Banks. This high liquidity released only moved to the investments in treasury instruments and to quote Subba Rao, former Governor, gave confidence to depositors in the Banking system that their monies are safe with the Banks, notwithstanding PMC Bank resolution still waiting at the doors of the RBI. It has two windows: one, investments and the other credit. The latest report on Investments not withstanding the $10mn investment announced by Google, all the investment projects are reported to be lagging behind and the cost over-run of the projects already swallowed the entire incentive package.

MSMEs are yet to come out of the two shocks of demonetization and GST. After the redefinition, and after a host of digital platforms placed within their reach, the access to credit by all counts is a poor show. Out of the National Credit Guarantee Trust linked credit incentive to the standard assets, Banks disbursed only 50% or less. This was supposed to be automatic release of 20% additional working capital. The second window to the stressed assets through Sub-ordinated debt is yet to open as the operating instructions were received only a few weeks back.

SIZE – AN IRRATIONAL CONCERN

Merger of PSBs taken up while the economy was slowing down is yet to show up the results. The market value of the SBI post-merger is way behind its peer, HDFC in the private sector. Sanctioning Rs.1200cr to a known defaulter in its books and erstwhile chronic NPA resolving through IBC, does not hold SBI in any high esteem either among global peers or its own clients. Government of India, by merging PSBs to 10 from 28 did not gain either in image or confidence of the people. Several clients say that corruption has become endemic in PSBs and not even acknowledging a complaint, or a letter of customer is so habitual that the latter are in the lurch.

While the Government’s efforts to digitize the delivery system have borne fruits reasonably going by the way the MNREG wages and other direct benefits reached the intended groups during the last two years, financial inclusion is way behind. The reach of banks to the poor has declined.

Regulator’s job is to make sure that the vertical and horizontal growth of institutions should not be allowed to go with a feeling that because of their size they are insulated from collapse and that the Government and regulator had to do something to keep them afloat even in the worst event like bankruptcy.  This is where the RBI should reformulate its views and ensure that the organizational structures irrespective of their affiliations do not overboard the governance and do not oversize.

The silos-based regulatory system currently in vogue, with the RBI regulating Banks and NBFCs, Stock Markets by the SEBI, Pensions by the Pension Fund Regulatory Development Authority, Insurance by the Insurance Regulatory Development Authority, and Commodity Futures by the Futures Market Commission should be effectively brought under Financial Services Regulatory Authority. Department of Financial Services, Union Ministry of Finance may have persons of eminence but when it comes to examining micro issues for macro management, it left lot to deliver. Collective wisdom needs to emerge to improve financial regulation and governance that affects 130bn people does not brook delay.  

India, for example does not have credit risk insurance of the order prevailing in either Italy, or Germany or South Africa.  The Credit Guarantee Trust for Micro and Small Enterprises is but a poor cousin of the trade and credit risk. Credit Risk could not be introduced in India as the IRDA was apprehensive of the consequences of credit default.  It is perhaps of the opinion that the moral turpitude would reach new dimensions if credit risk is introduced. 

Percy Mistry Committee called for a unified regulatory architecture for resolving issues dealing with segmentation of financial markets into banking, capital markets, insurance, pensions, derivatives etc. Sweden, Singapore, UAE, UK, Republic of Korea to cite a few have already moved into the unified regulatory system.

OPERATIONAL ISSSUES:

Warren Buffet, the most reputed investor, is quoted at number of places: “Derivatives were financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal.” Over-the-counter derivatives that are off-balance sheet instruments come to surface suddenly when their collaterals fall and when their values become riskier to hold, killing in one stroke rest of the healthy assets of the Banks. The delivery and recipient systems have not reached a level of maturity to play with them, even a decade after their active entry.  Indian financial system cannot afford the consequences of systemic risks arising from their instrumentality.

Let me go to the most familiar area – Credit Risk that is mostly understood as risk of default.  Here the risks arising from asymmetric information have not been dealt with. The Credit Information Bureau India Ltd.,(CIBIL) is the only institution that currently unfolds client’s historic information at  price.  Entry of multiple players with the enactment of Credit Information Services Act of 2005 is put on hold.  Trade and Credit information services should enter the competitive domain for the information system to get into a semblance of order.

Credit rating agencies in India that are approved by the RBI are none other than the Fitch, Standard and Poor, Moodys etc., whose ratings busted on the threshold of sub-prime crisis and beyond.  There is no proof that they are doing their job differently.  Until the rating agencies’ services are paid for by the financing institutions that make use of the ratings and hold them accountable for the ratings, there is no guarantee that the ratings per se would add to the quality of the credit portfolio the banks carry in respect of the rated assets. 

While the Government and the RBI, Insurance and Capital Market regulatory authorities have proved one-upmanship over the other regulatory authorities in reasonably insulating the Indian Financial System from the impacts of the current global crisis, a large gap remains in what is needed to be done. The time to put things in the right shape is now and right away.

It is high time to appoint a High-level Committee that should also include outside experts to clean up the banking system with an open mind.

------------------------------------------------------------------------------------------------------------*The Author is an Economist with three decades of banking experience and a Risk Management Specialist He can be reached at yerramr@gmail.com The views are author’s own.

https://www.moneylife.in/article/ramping-up-the-banks-india-needs-to-do-something-more-crisis-or-no-crisis/60966.html

Uion Budget 2020 worrisome

Hardly the time for a tight fisted Budget 2020-21

FM in her second year of budget presentation has very unenviable task in performing a balancing act. GST revenues are looking southwards and the input tax credit, the key for success of GST is mired in data upload controversy and hostile inverted duty structure. Markets do not seem to worry about this going by the forward movement of indices, blowing against the wind.

PSBs absorbed all the capital that the government buffeted and yet did not perform. On top, some banks have acquired the notoriety in manipulating balance sheets. Frauds have surfaced like never before to Rs.71,543cr – a rise of 74% over the previous year in the financial sector. NBFCs too joined the cry for capital or regulatory relaxations.

Through legal process – IBC, SARFAESI Act, DRT and Lok Adalats, 14.9% in 2017-18 and 15.5% in 2018-19 is the amount recovered out of the claims lodged. Recovery through IBC at 42.5% is the highest, while it is 3.5% through DRTs, the lowest, according to RBI -M&M Economic Research.

No economic recovery will be possible with a crippling banking sector like the one we have today. Some Banks having Insurance and Mutual Funds are still entrusting targets under these subsidiaries to the regular banking staff taking away their productive time for selling banking products like deposits, credit and digital services.

Creating demand in rural, semi-urban, and urban areas would occur when the people have enough money in their hands. Credit has not moved in tandem with the demand from farmers and MSMEs in manufacturing. RBI doing its job by reduction of 135 basis points in the base rate has no spread effect in retail lending market as there is no risk appetite among banks.

Knowledge in banking products and services has come down significantly among line staff and this is the reason for credit origination risk escalating to failure in repayments. Capital infusion without rectification of the basic malaise and governance, will not address the problems.

Why worry about fiscal deficit when the denominator GDP has many undisclosed data escaping entries? Several economists make mountain of mole hill while speaking about fiscal deficit. Right from the Union Finance Ministry to the regulators, all converge on the fact that the slowdown of the economy is real and need demand boosters. There were occasions when we reached around 6-6.5 percent (2008-11) of GDP and the economy registered growth thereafter.

The worry on employment growth is real. Unemployed youth hitting the streets would exacerbate the security risks. Industry, despite the skill development initiatives, bemoans that they do not find the right persons for the right job.

Sector-wise, agriculture grew 2 percent while manufacture showed less than 1%. Make in India, the flagship manufacturing initiative has not shown uptick during the last four years in continuum. Services sector too is showing decline.

Priced education and health have made increasing demands on the government. Several States and Union Government have schemes like Arogya Sri, Kutumba Sri, Ayushman Bharati etc., and yet their reach to the intended is still facing issues in payment for the services to the hospitals. Affordability is still an issue.

What should be the measures in the budget to boost employment? Which sectors need focused attention from such perspective by way of fiscal incentives? How can the States be brought on the same page as the Union Government?

The slowdown is both cyclical and structural. There should be consensus between the States and Union Government on the way forward. Union Government should release post-haste all the payments for the pending works under MNREGS.

Several States and Union Government have huge arrears to suppliers, contractors and sub-contractors for several project works that has choked the bank working capital releases and all these payments should be released to the last pie.

The paltry pension to farmers at Rs.6000 per annum should be altered to Rs.12000 per cultivator whereby even the tenant farmers would be eligible for pension payment after 60 years. Since the scheme envisages payment by the farmer between 40 and 60 years of age his/her contribution, several farmers who are of 60 and above right now, would not be benefitting from the scheme. The scheme should benefit those who are above 60 now. Adequate budgetary provision is necessary.

Budget allocation for health sector should significantly go up to a minimum of 6% of the total outlay from both the States and Union. Health infrastructure is pretty poor and needs improvement.

Education budget should target universal education up to Class 12 and this happens when teacher pupil ratio significantly improves, and school infrastructure also improves. National Education Policy shall indicate the prospect of resource allocation as well.

Ensuing Budget should convert intent into actionable allocations in the critical sectors and lay a path firmly for cleaning up the banking sector. Frustration should not be at the breaking point.

Published in the Hindu Business Line, 3.1.2020

www.thehindubusinessline.com

PSB Goverance

Crisis in PSBs - I: What is the Responsibility of the Government as the Owner?

Moneylife Digital Team
29 July 2019

The government-owned, or public sector banks (PSBs), which are under severe stress, require an urgent surgical strike. Bulging non-performing assets (NPAs), increasing frauds, and declining credit to the key sectors is worrying. Moneylifehas laid bare many of the frauds and misdemeanours of the commercial banks that included Syndicate Bank (2014), Bank of Baroda (2015), Punjab National Bank (2017), to mention a key few. The free ride of businessmen started eroding confidence in banks due to questionable lending practices in PSBs.

 The rot goes deep. For example, what are the answers to these questions?

1. All limits above Rs5bn should be sanctioned by the board duly overseen by the risk management committee. Banks also have internal audits, statutory audits and financial inspection of banks by the Reserve Bank of India (RBI) annually. Then how were such limits sanctioned without due diligence of directors on the boards of top-12 defaulting companies referred to the Insolvency and Bankruptcy Code (IBC) in 2017? What role did various committees play during the currency of the loan?

2. Even after the roles of managing director (MD) and chairman are separated, why couldn’t the non-executive chairman provide the required guidance to the board in enforcing accountability and transparency?

3. Why did the banks fail in due diligence of directors of the companies to which they sanctioned loans? It was noticed in several cases that the directors held suspicious transactions with other boards or companies but did not go on record as such. Integrity of the borrowers was taken for granted, going by the way banks nurtured the accounts.

4. Why and how were the banks allowed to hold the accounts with recovery actions far beyond 90 days in regard to all the major corporate advances?

5. When the RBI is represented on the board and with data on non-performing assets (NPAs) and corporate advances and the analytics of the financial stability reports coming out every quarter, why could it not contain the contagion of NPAs?

6. Why couldn’t the RBI director on the board insist on the audit committee to steer clear of acts that led to prompt corrective action (PCA)?

7. All the banks are subject to risk based supervision by the RBI. Then how could the banks manage such supervision and yet hide the processes that led to the frauds that surfaced later?

8. What is the role played by the nominee director of government of India in the board approvals and the NPA status of the bank concerned? 

9. Did the board of any bank give a strategic direction to the MD and monitor such direction subsequently?

10. When government of India (GoI) directed merger of associate banks with State Bank of India (SBI) or later the merger of two other PSBs with Bank of Baroda, fait accompli, the boards passed a resolution favoring the mergers and the consequences and the impacts on customers and other stakeholders were hardly discussed and there were also no voices of either concern or dissent. The role played by independent directors becomes significant in such situations. 

Clearly PSBs are facing a huge goverance deficit. Year after year, volumes involved in frauds have only increased, notwithstanding the existence of internal chief vigilance officer, external vigilance commission, system audit, risk audit, stock audit, concurrent audit, and annual internal inspections by the banks’ own audit team, external statutory audit, forensic audit and the annual audit of the bank by the RBI approved chartered accountant firm. PNB fraudsters successfully hoodwinked all of them. 

The question is: What is the role of the owner, regulator and controller of PSBs? The government has announced recapitalisation to the extent of Rs211,000 crore to meet the regulatory capital requirement once Basel III becomes operational (Basel III implementation date has since been extended to April 2019 from April 2018).

The present finance minister, sailing with the wind, again provided another Rs70,000 crore capitalisation in the next nine months.

Many experts feel that good (taxpayers’) money is flowing to the bad (crooks) with no accountability.

Although the government seemed to recognise the need for reforms, it fell short of introducing the structural changes suggested in the report. At the root of the rot lies poor governance and the absence of ethics. Ethics took a hard beating and governance is in utter disarray against the backdrop of unlearnt lessons of similar past offences, both within the bank and outside. Bad banking has now become a major concern of the body politic. 

It is the boards that should make the difference between the most successful and the unsuccessful corporate, whether in banking or elsewhere. Managerial efficiency, risk management systems and efficient governance require urgent attention. 

The Financial Times had held a series of debates in 2013 on better boards and corporate governance. The strong message that emanates from the debates is that fewer rules and more significant consequences for breaking them would make a lot of sense. Further, it is not good to have one-size-fits-all approach to corporate governance and the organisations should be empowered to craft their own systems of governance.

Narasimham Committee-1 made some significant recommendations regarding governance that would require a re-visit.

Ownership Issues

SBI has its chairman, MDs and deputy MDs (DMDs) as members of its board. PSB boards have been reconstituted in line with the recommendation of PJ Nayak committee with MD and non-executive chairman as two separate positions with both of them requiring the approval of the RBI. 

MD of PSBs are selected by banks board bureau (BBB) since 2015. BBB proved not so effective with long delays in filling the top positions of several banks and overbearing influence of ministry of finance (MoF) in the selection process. SBI post-merger and PSBs have individual shareholders who include even employees and retired employees of the banks as minority shareholders. This status involves the issue of protecting the interests of minority shareholders as well.  

Ownership, governance and regulation have created inconvenient compromises in the PSBs. The roles of owner and regulator combined in GoI have a built-in conflict. The presence of RBI in banks’ boards is further conflict of interest. The Narasimham Committee -1 recommended 25 years ago that RBI should dissociate itself from bank boards. This obvious step has still not been taken.

The role and functions of the ethics committee have not been well defined. The board should have full authority for appointment of statutory auditors with no role for the RBI. But going by the experience of the failures of banks such as the Global Trust Bank Ltd, RBI decided that the auditor firm should be from its approved list. 

The GoI has a strong lock on the banking sector but talks of competition in banks, independence and autonomy. It plants its officials from the finance ministry as directors on PSB boards. At best, these nominated directors carry the proceedings with their own interpretation to the ministry, and such interpretation may cause some unintended consequences to the banks they serve. 

How Do We Avoid Conflict of Interest?

A governance code could have guidelines for the management on its behaviour patterns because it is they who are running the institution and making the day-to-day decisions and their behaviour will be of greater consequence to the functioning of the bank than that of the board that meets at pre-determined intervals. The ‘comply and explain’ requirements should be very clear and unambiguous. Non-negotiable rules would lessen the complexity of corporate governance from the investors’ perspective. 

In India, unlike in some European two-tier boards and unlike in UK, the boards of PSBs, provide for employee representatives too on boards from the workers and officers.

Although several PSBs in the wake of financial sector reforms allotted shares to their employees it is not necessary that the workmen directors need be shareholders. Systems of governance should be focused on empowering front-line staff—rather than trying to keep them in check, even the  debates in Financial Times concluded.

Though stakeholders’ interests should weigh more than those of the shareholders, it is the lack of ownership culture among this set of non-executive directors (NEDs) that results in their performance below the expectations of the group they represent and that should cause worry. This constituency of stakeholder on the board needs careful treatment and nurturing. Employees and pensioners would be a growing constituency and they should have a place in the board as part of minority interests’ protection. 

Audits and Audit Committees

Banks that complain of multiple audits interfering with their business could not justify the concern due to the alarming rise in financial irregularities and poor credit risk management. Systems have become vulnerable to intrusions putting the banks to losses not seen before. Therefore, system audits have assumed critical importance. 

The complexities of the systems are on the increase with increasing role for them—both in operational and instructional matters. There is a growing trend of addressing any customer grievance only through an instruction embedded in the system. Almost all banks have been generating only e-circulars. The employees and managers hardly go through them save exceptions – those in the regional/zonal/head/central offices. The ability of the banks to put them to institutional learning periodically is also dwindling. Learning mechanisms seem to have been severely impaired. This leads to unnerving top management not generally admitted in public but discussed internally. The board has a responsibility through the HR (human resource) committee to resolve such a dilemma. 

Need for an Independent Director with knowledge of Technology 

The world over, technology risks and cyber risks are overcrowding the banks and financial institutions. Michael Bloch et al of McKinsey in their "Elevating Technology to the Boardroom Agenda Report (2012)" insists that the boards call for periodic reviews of technology’s long-term role in the industry by pushing the IT jargon the background and bringing in the right people to the board meetings for discussions on technology adoption. 

Leveraging technology savvy board members and strengthening technology governance structure by delegating the related risk issues to the board committee that oversees the risk management portfolio are some of the key suggestions worthy of consideration.

Good Governance Requires More Than Rule Fixes

Universal banking that permitted the banks to take to finance housing, real estate, retail loans, and sell third-party products, like insurance, mutual funds, pension funds etc, followed by digital banking, has made banking a non-core activity with overwhelming incentives for performing non-banking functions. 

Banks insure their own assets with the general insurance companies. Bank employees are expected to handle the banking products of deposit, credit and investments and not insurance and mutual fund products. 

Boards were silent spectators when the banks were measuring executive and employee performance based on the earnings on third-party products. 

During 2018, MoF directed the banks not to pass on any incentive for selling third-party products to any employee or executive and the benefit of such business should be accounted for in the profit of banks. Thereafter, PSBs started refocusing on banking business. Performance evaluation criteria should be overseen by the board. Boards, therefore, have a serious challenge in HR management oversight.

RBI should approve those directors on bank boards who are of impeccable integrity and unquestionable character, with no role conflict at any point of time.

The ‘fit and proper’ criteria prescribed by the RBI need revision. It is desirable that the selected person should be asked to give a two-page write up on his knowledge of the board functioning; his intended contribution, and his relationships with the other directors on the board and of his views on the present management, as a third eye from the published data and information, as obtaining with the Netherland banks. 

This statement can be reviewed by the regulators who may even seek clarifications where necessary before confirming the appointment. Knowledge and culture are two different aspects though synchronisation would enhance the value of the person. Such a write-up from the prospective director, therefore, can help in self-assessment of the director and performance assessment of the board itself eventually.

The annual general meetings (AGM) should not end up as the presentation of the audited statement of accounts to the general body; it should have group discussions of the shareholders on wide ranging issues like the strategies, risk appetite and risk culture in the organisation. In the alternative, it is also worthwhile to have board retreats for two days annually for self-evaluation and the way forward prior to the AGM and have at the AGM a synopsis of the discussions in the retreats,  as a guide for future.

It is the banks that could alone answer these questions as board documents are confidential. The best way to prevent such transactions is to strengthen corporate governance by the regulators/supervisors at once disassociating themselves from being on the boards of all categories of banks.

*The Author is an economist and Risk Management specialist. These series of articles are the abridged version of the NIBM Conference (July5-6, 2019) Paper on “Good Corporate Governance – the Best way for resolving the Indian Banking Crisis”. The views are personal.

  

Fragility to Fast Track?

Arun Jailtley mentioned that the UPA’s fragile economy is on fast track now. CSO forecast of GDP growth on the eve of the Budget 2018-19, however, is 6.5%, the slowest of the last four years. What has moved fast?

Union Budget presentation moved from March end to February end. Insolvency and Bankruptcy Code completed its first anniversary. But the MSMEs are yet to get their deal. All the goods carriers from North East to down South Kerala move without any check post hurdles and the palm greasing saving nearly Rs.30000cr for various companies. Indirect Tax Reforms through GST with all its initial hiccups is still with glitches. Tax compliance moved an inch up on direct taxes although only 1.2% of the tax filers paid taxes.