Prickly Problem of Piddly Private Banks: Are Small Banks the Elephant in the Room?
The managing director and chief executive officer (MD&CEO) of Tamilnad Mercantile Bank sent in his resignation letter on 28th September citing personal reasons for the decision. He had joined the bank on 4 September 2022, just a year back. The Bank was flying on a single engine with just one whole-time director!
 
The Bank was recently the target of many memes in social media for its lapse in crediting a sum of Rs9,000 crore to the account of a taxi-driver who, thankfully, did not lose his life seeing an 11-digit sum in his bank account!
 
The Bank was also under scrutiny by the tax department for alleged errors in some tax filings. The details are not known.
 
A few days back, one of the independent directors of Dhanalaxmi Bank resigned and the reasons provided bordered on accusing the board of a conduct that would be unworthy of a gang of robbers!
The debacle of a century-old Laxmi Vilas Bank, about three years back, due to stark mismanagement, is still green in the memory of all.
 
Besides the above-mentioned issues, the fact is that banks that are regional in character and small in size have serious issues keeping pace with the needs of the time when the financial services industry is going through a revolution of technology and talent acquisition.
 
Another one, City Union Bank, has been helmed by the members of the same family for the large part of the past four decades. The present incumbent got a three-year renewal by Reserve Bank of India (RBI) in April 2023 and has been MD since May 2011, before which he was the executive director (ED). The father of the incumbent was at the helm for over two decades till his demise in 2004. 
 
The Bank has come under severe criticism recently for underperformance when the industry has shown overall great promise. Ostensibly, there is no significant shareholding that drives this hold of the family but perhaps the local factors and familiar faces on the board help to keep this stranglehold. RBI seems guided by the regulations that allow a 15-year stint as MD of a bank than look at the performance angle critically.
 
These banks, given their vintage, as some are centurions, did come about at a point in time when banking was a community and a local phenomenon where people would trust only known faces with their savings and the bank, in turn, would lend only to known borrowers in a local area.
 
Over time, they have managed to foray outside their core area of functioning but still the outlook and culture are very regional and parochial.
 
The fact that they are still headquartered in relatively small towns like Tuticorin, Kumbakonam or Karur (just examples) shows their anchoring in the specific regions and the influence of the local community in the larger scheme of things of their functioning. Their board composition also reflects the point made here.
 
To get a sense of the size involved, the cumulative market-cap of a sample of six private banks that fit into this discussion sums up to a number that is a third of that of a shadow bank that was recently listed with great fanfare and which is yet to show some business on its books!
 
These banks, taken entirely at random, all from the Dakshina Bharath area, are: Dhanalaxmi Bank (Rs743 crore), City Union Bank (Rs9,384 crore) Karnataka Bank (Rs7,796 crore), Karur Vysya Bank (Rs10,766 crore), The South Indian Bank (Rs5,587 crore) and Tamilnadu Mercantile Bank (Rs8,609 crore). All figures in the brackets are the recent market-cap figures.
 
The market-cap of Jio Finance—Rs1.47trn (trillion) is about three times the cumulative figure!
 
The deposits cumulatively managed by these banks are about Rs4.2trn and the advances made are less than Rs3.0trn. The branches number around 4000. The figures are FY22-23 for all except Dhanalaxmi and KVB which are for FY21-22.
 
The question is: are these optimal sizes to operate a full-service bank with all the required technology infrastructure and human capital?
 
Banking, which may have originated as a community activity of channeling savings and lending, has changed beyond recognition and is a sector that is more impacted by technological changes than any other.
 
The instance of a wrong credit of Rs9,000 crore mentioned earlier would never have arisen half a century back as no teller would have made such an error! But it is the technology that is the culprit for such an occurrence; and technology is supposed to be the panacea to all problems of management!
 
Another key aspect is these banks are operated as a turf of a particular community or a close set of families though the shareholding may not reflect this in all cases.
 
LVB was a classic case of a tussle for control, complete mismanagement and diversion of funds, destroying shareholder value and creating a major crisis for the system till the regulator made its much-delayed entry to resolve it.
 
It would be unfair to paint a picture that governance lapses happen only in such regional and small banks. ICICI Bank and YES Bank were neither regional nor small.
 
Yet, the serious question for the regulator is whether there is a continuing rationale to allow the system to be as it is or whether an alternative should be explored considering the case history as seen in recent times in some of these banks and the emerging challenges in this sector.
 
It is quite obvious that banks have to be closely supervised as poor oversight caused serious havoc even in the so-called advanced economies like the US and Europe, and all that was not a century back but less than a year ago!
 
There are many examples across the decades and enough recent ones of poor governance and inadequate audits, by the statutory auditors and by the regulator, and the consequence to the depositors and the investors.
 
The case to minimise systemic risks that even a collapse of a small bank can cause needs no emphasis. Some time back, the number of government banks was rationalised and the smaller and weaker banks were collapsed into bigger ones.
 
The arena of private banks needs that rationalisation touch as well.
 
A straight merger may not go well with the system, though it is ideal. An alternative can be to link each of the small private banks to a specific bigger bank to act as a mentor. The bigger bank can take a reasonable stake and take responsibility for key areas like governance, technology and human resources. A three-year road map to a final merger should help prepare the ground well.
 
This may also help rationalise branch openings and make key technology investments which individually may be quite suboptimal for these tiny ones.
 
Recently, a few mutual funds sought the permission of the regulator to increase the shareholding in such regional banks. That may be the compulsion of the nature of those schemes which can only invest in a particular size like small or micro caps or sectoral stocks. Nevertheless, such actions indicate an overall demand for such stocks. The question is how effective the funds are in improving the governance and the quality of the board and management.
 
The market-cap of these banks is a good indicator of the comfort that the investing public has with these banks. There cannot be a better metric of the value proposition offered by these entities. The poor discounting that affects the share price is primarily on account of the concerns on the governance.
 
Should RBI be looking for other smoke signals to act?
 
(Ranganathan V is a CA and CS. He has over 43 years of experience in the corporate sector and in consultancy. For 17 years, he worked as Director and Partner in Ernst & Young LLP and three years as senior advisor post-retirement handling the task of building the Chennai and Hyderabad practice of E&Y in tax and regulatory space. Currently, he serves as an independent director on the board of four companies)
Comments
canraram
8 months ago
Sir, while your suggestion is debatable, it is like merging ACA, ACS,ICWA,CMA all into a single venture. Whether the respective institutes will accept it. Given the technological advancement made in all sectors, the brick and mortar of CA,CS,CMA have made their approach to be a subsidary of technology i.e. it is needed for them to excel in the system level part of it from an CA,CS, or CMA angle. Humourously, i am a tech expert in system with a CA,CS,WA or CMA qualification.
As the author suggested, attaching or tethering to a bigger bank, is it a solution. Merging of 2 big banks like Canara and Syndicate, effectively destroyed the culture of both the bank and going forward time only will tell.
Merger or tethering is not a solution for oversight failures. The RBI which in the case of Laxmi Vilas bank or during the demonitisation period when it distributed 85 % of cash to 15% of banks like Axis,Kotak, ICICI is no puritan in its functionality. In all the issues, that have been pointed out, one thing that commonly and clearly stands out is oversight of RBI was not at its best.
Whey does not the RBI overhaul itself properly to see that the Banks retain their culture as also give effective return to the stakeholders.
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