Banks have come a long way from the days of deliberate acts of concealing the true state of affairs. “System generated” NPA is a necessary step in cleaning up the financials of banks which the RBI rightly directed

Last week Dr KC Chakrabarty, deputy governor of the Reserve Bank of India (RBI) made a sweeping charge in the Banking Technology Summit organised by CII that the banks, by attributing the increase in NPAs (non-performing assets) during 2011-2012 to the adoption of system-based capturing of NPA data, have misled the investors by reporting inaccurate figures of NPAs for the past five years. Continuing his lambaste, he incited SEBI (Securities and Exchange Board of India), the capital market regulator, to take action against the publicly-listed banks which include all of the Public Sector banks (PSBs). He missed exhorting  the public shareholders, who now hold substantial chunk of shares in PSBs, to question the banks, their auditors, indeed the board of directors (in which the RBI has a nominee and the government has quite a few part-time nominee directors), for approving  accounts which did not reflect "True and Fair" view of the financials. By extension, the RBI which conducts Annual Financial Inspection (AFI) needs to be asked the same question. The public shareholders need to gain courage from TCI, which with just 2% shareholding  challenged Coal India  on  its pricing policy as guided by the government on the ground that, "If they (government) choose to list a company, they have to treat minority shareholders with respect. They were committed to running the business in a professional manner".

Dr Chakrabarty could not have been unaware of the practices of reporting of NPAs in PSBs as he was the CMD of two public sector banks- Indian bank, one time a weak PSB, and Punjab National bank-prior to his becoming the deputy governor. Generally speaking, banks in the past endevoured to show diminished figure of NPAs, in such of those loans where the departure from the strict criteria of identification of NPA, was 'minor' which the statutory auditor accepted as reasonable. For example it is possible that when interest or repayment installment was received only a few days after it fell due, the loan was treated as a performing asset. It is also possible that some branches, with or without the backing of the controlling office, might have resorted to "ever greening" a loan account prone to default, by granting an additional/ fresh loan to recover interest, or installment to avoid the loan becoming a NPA. Most of such cases, anecdotally speaking, took place in priority sector portfolio spread over thousands of bank branches manned by managers of varying dexterity, and where the decision on treating a loan as NPA or not, tended to be accommodative.

Yet another device adopted by banks and erstwhile long-term financial institutions was to restructure loans to avoid a loan being classified as non-standard. This was resorted to in the case of some large loans; such restructuring on paper seemed fairly well justified. In fact in the wake of financial turmoil experienced globally since 2008, the RBI itself suggested restructuring of loans with some well laid down conditions. To quote, "As one time measure and for a limited period, prudential regulations for restricted accounts were modified for applications received upto March 31, 2009. The modification in regulations for restructuring was effected to preserve economic and productive value of assets which were otherwise viable. The modifications permitted restructured accounts to be treated as standard assets---even if they turned non-performing at the time of restructuring'. [Emphasis added]. Given that India could not remain unaffected by the global affliction, the RBI cannot be faulted for not following its own norms. It was justly being pragmatic.

To add to the above stated factors, there might have been interpretational issues of the instructions on NPAs, though such cases perhaps were not common. To cover such rare cases as well, the RBI requires banks to provide in the following year for any loan account, which its Annual Financial Inspection qualifies as NPA, contrary to the treatment accorded by the bank concerned while finalizing accounts at the year end.  In passing, a curious case is worth mentioning. Following the assurance from the central government in a meeting which was attended by the Maharashtra government representative, the RBI nominee and lender banks, to Rathnagiri Gas &Power Pvt Ltd (Erstwhile Enron, India), all banks treated the exposure amounting to over Rs9,000 crore as standard asset but statutory auditors of one or two banks with relatively small exposure treated them as substandard loans as the government/ RBI's decision was not received in writing. RBI's AFI auditors of these banks upheld the decision of treating the exposure as non-standard but RBI AFI teams elsewhere did not dispute the classification of the same loan as standard asset in other banks in the consortium!

 It is in context to recall the 1980s in which banks were tacitly encouraged to fudge their financials (for reasons of political expediency) to somehow show profit; this manipulation of accounts of banks was over in early 1990s as the banks adopted prudential norms following Basel I recommendations. It is worthwhile recalling the findings of the report of the working group on "Restructuring Weak Public sector Banks" (Indian Bank, Uco Bank, United Bank) {better known as Verma Committee Report}. To quote, "Till the adoption of the prudential norms, 26 out of 27 public sector banks were reporting profits. In the post-reform year, i.e. 1992-93, the profitability of the PSBs as a group turned negative with as many as 12 natinalised banks reporting net losses". The RBI, it must be said to its credit, knowing the circumstances was pragmatic in allowing 4/5 years for a graduated nursing of banks to health. Had it panicked, some banks could have collapsed.

Banks have come a long way from the days of deliberate acts of concealing true state of affairs under political pressure. The banking system, without wishing away the problem of NPAs, is basically sound. More important issue to be examined ought to be the seriously worrying aspects of the working of BIFR, DRTs, on the one hand, and CDR mechanism on the other. In actuality the first two entities are dysfunctional, or weary of their statutory objectives. The CDR mechanism is allegedly in the grip of Asset Reconstruction Companies (ARCs) and the original intention seemed to have yielded place to profiteering at the cost of banking system. We will revert to this topic soon.

As of now, all that can be stated is that the system generated NPA is a necessary step in cleaning up the financials of banks which the RBI rightly directed. System-based identification does not permit any latitude to banks and hence, the rise in NPAs last year became inevitable. We need to view the issue with contemporaneous perspective, without undue alarm. Dr Chakrabarty, with the insider knowledge of heading the two commercial banks and having been a part of the some pragmatic policy initiatives of the RBI in the face of global financial meltdown, could have been less preachy instead of showing off his mantle as savior of banking system.

 (A Banker is the pseudonym for a very senior banker who retired at the highest level in the profession.)