Ramping up the Banks: India Needs To Do Something More… Crisis or No Crisis
The anniversary of banks’ nationalisation in India passed off on Sunday. Smiles were Scarce; no one would talk of the village adoption scheme; no chairman would go to a village these days to see how their rural branches are helping the farmers or how the medium, small and micro enterprises (MSME) sector is being financed. There is neither pride in ownership, nor regret for bad governance. 
 
But for a full-page pull-out by the All India Bank Employees’ Association (AIBEA) on 20 July 2020, who remembers the bank nationalisation 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 about wearing masks and sanitising their palms before handling the currency received from outsiders. Everyone cries wolf on the ever-bulging non-performing assets (NPAs). The only solid reform that we can boast of is the Insolvency and Bankruptcy Code (IBC). Job creation is hurt badly in the organised sector with near-65% of MSMEs shutting their windows in the pandemic. Their markets are yet to revive.
 
Banks in UK, Iceland, and even the US resorted to the most criticised and least preferred route of nationalisation of banks, when they confronted a crisis. Then, the Obama initiative that received positive response from stock markets since the announcement of the 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 shortly, the 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 has set in due to the pandemic. No prediction as to when it would end makes sense. Annual balance sheets for 2020 are waiting for finalisation 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 realise its distinction in the emerging economic scenario and how necessary it is to turn the head on the screws. 
 
At the commencement of COVID-19 attack, India did well and even till now, we do not find people scrambling for food because farmers 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, International Monetary Fund (IMF) and World Bank kept the ratings low and estimated a growth of 42% in 2021. Opening the economy with a lot of courage has not been taken too kindly by coronavirus that has been surging every day crossing the one million mark. India took the 4th rank the world among the coronavirus affected nations.
 
Second, our 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 derivatives markets in our anxiety to mix with the globe. World Trade Organisation (WTO) is 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. Rural areas, where still 65% of our population lives, drive the demand growth.  Having said that, here are some facts that can be hardly ignored: there is a steep decline in job growth; steep declines have also set in 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 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 RBI’s advice to pump in credit. 
 
Atmanirbhar Bharat Abhiyan, the stimuli announced to combat COVID-19, injecting more than Rs20 lakh crore liquidity, still faces 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 the 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, notwithstanding the $10mn investment announced by Google, shows that all the investment projects are reported to be lagging behind and the cost over-run of the projects has already swallowed the entire incentive package. 
 
MSMEs are yet to come out of the two shocks of demonetisation and the goods and services tax (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 State Bank of India (SBI) post-merger is way behind its peer, HDFC in the private sector. Sanctioning Rs1,200 crore to a known defaulter in its books and erstwhile chronic NPA resolving through the 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 a customer is so habitual that the latter are in the lurch.
 
While the government’s efforts to digitise the delivery system have borne fruits reasonably well, going by the way the Mahatma Gandhi National Rural Employment Guarantee (MNREG) wages and other direct benefits reached the intended groups during the past two years, financial inclusion remains way behind. The reach of the 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 the regulator must 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 organisational structures, irrespective of their affiliations, do not overburden governance and do not oversize banks. 
 
The silos-based regulatory system currently in vogue, with the banks and the non-banking finance companies (NBFCs) being regulated by the RBI, 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 a 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 leaves a lot to deliver. Collective wisdom needs to emerge to improve financial regulation and a governance that affects 130bn people, brooks no 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, the Republic of Korea, to cite a few, have already moved into the unified regulatory system. 
 
Operational Issues
Warren Buffett, the most reputed investor, is quoted at a 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 the surface suddenly when their collaterals fall and when their values become riskier to hold, killing in one stroke the 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 a client’s historic information at a 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’s and Poor (S&P) and Moody’s., 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 their 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 we appointed 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 [email protected] The views are author’s own.)
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    COMMENTS

    Ramesh Popat

    2 weeks ago

    too much written on sickness of psu banks!

    Despite Policies in Place, Corporate Governance in PSBs Remains a Work-in-Progress Project
    What has been happening in the banking sector during the past six years should have been a matter for serious introspection and concrete corrective actions by the Union government to clean the proverbial Augean stables. There was hope in 2015, when a conclave of top executives of banks called ‘gyansangam’ was held, followed by the announcement of a package of measures called indradhanush.
     
    Recapitalisation was one measure to enable the ailing public sector banks (PSBs) to shore up their capital. More importantly, the government announced that improving corporate governance would be a major area of reform in the years to follow. The report of the PJ Nayak Committee on Corporate Governance (2014) was to be a starting point of such reforms.
     
    As a sequel to this, Banks Board Bureau (BBB) was set up in March 2016 with Vinod Rai, former Comptroller & Auditor General (CAG) of India as the chairman with six members. Although it did not have an explicit mandate on measures required to tone up the ailing PSBs, it started off in right earnest and took certain initiatives on its own to cover critical areas in the functioning of PSBs. Through meetings with the political bosses, bureaucrats, bankers, RBI officials and Indian Banks’ Association, BBB itself tried to evolve a mandate for reforming the banks. Its compendium of recommendations (CoR) submitted in March 2018 a few days before Vinod Rai demitted his office, provided a broad framework for reforms so urgently needed. 
     
    Parallel to this, the government went ahead with the plan of consolidating PSBs. Through three rounds of mergers, 28 PSBs have been consolidated into 12. The first two mergers respectively of SBI group, and of Bank of Baroda have not yet yielded the claimed benefits to the anchor banks. The latest round is still a work-in-progress; it will be too optimistic to expect that miracles will happen during the next two years. The process itself is incomplete as the candidates left out of the merger exercises are not in good shape, which makes another round of mergers probable. Reports have also appeared that some of them may be privatised.
     
    In the meantime, there is virtually no progress in the area of corporate governance in PSBs. On the contrary, the government has taken two disjointed measures, namely, increasing the number of executive directors to four and creating a new tier of top executives designated as chief general managers making the PSBs top-heavy. Their respective roles have not been spelt out, leaving the job to the boards. 
     
    The boards continue to remain truncated as most of the PSBs do not have the full complement of directors. Two of the six big banks have no chairmen; in none of them have the mandatory officers’ and workmen’s directors been appointed during the past four years. Punjab National Bank, the largest PSB after SBI, has only eight directors; so also, the Bank of India and the Indian Bank. (See the table given at the end). Such ad-hocism is not consistent with the objective of corporate governance.
     
    RBI’s New Proposal 
    Meanwhile, a new discussion paper on bank governance (DPG) put in the public domain by RBI attempts to bring the issue to the limelight once again. The DPG is a good starting point for a thorough rethink on the kind of reforms the PSBs should be subjected to in the years ahead. 
     
    The principal thrust of the proposals is on making the banks board-driven, as it ideally should be. Greatly influenced by the recommendations of Basel Committee on Banking Supervision (2015) and drawing from the inputs of CoR of BBB, RBI has laid down a road map for overhauling the current system of governance in PSBs. 
     
    The board of directors is given a range of responsibilities beyond its conventional role. At present its role is limited to giving broad directions to the bank as recommended by the top management led by the managing director and chief executive officer (MD/CEO) and in conformity with the policy and administrative guidelines issued by the government and regulatory requirements stipulated by RBI.
     
    According to the DPG, specially constituted sub-committees of the board will be given a dominant role of policy-making, implementing, monitoring and evaluating with the help of designated top executives. The scope for conflict of interest between revenue generation and control functions and the consequent vulnerabilities is sought to be reduced by clearly laying down the respective responsibility areas. 
     
    Three committees will be assigned crucial roles in the proposed structure: the risk management committee (RMB), the audit committee (ACB) and the remuneration and compensation committee (RCB).
     
    Each one of them would be headed by a non-executive director with independent directors as their members. Four designated officials will be in charge of specific areas of responsibilities and they will be answerable to these committees. The chief risk officer (CRO), the chief compliance officer (CCO), the head-internal audit (HIA) and, chief-internal vigilance (CIV) who would ideally be one rank below the executive director (ED), will carry out the mandates of the committees and the board, and provide the necessary support to discharge their roles. 
     
    The board will also be responsible for selecting and appointing directors representing different interests. A board can have a maximum of 15 directors with a majority being independent directors. All meetings of the board must have a majority of independent directors.
     
    Three Levels of Defence
    DPG identifies three levels of defence for the banks—one at the front level which runs the business, the second at the controlling unit level addressing the risks and the third one looking after inspection and vigilance. 
     
    The first line of defence comprises the business units which are manned by the field staff. They are expected to carry out the business of the bank in conformity with the mandate given by the board in its ‘risk appetite statement’ (RAS), which, in conventional lexicon, implies lending policy and guidelines. They are also accountable for managing the risks. It is the board’s responsibility to evolve and promote an efficient risk culture in the bank to be followed, among others, by the front-line staff.
     
    The second level of defence is provided by the controlling units at different levels. It includes the risk management and compliance functions. The former will oversee the risks and monitor the activities of the first line.  The compliance function will monitor the compliance with the policies and guidelines issued by the government, the regulator and the bank’s board.  
     
    The third level of defence comprises the internal audit and the vigilance functions. They would be independent of the first line and will assess if the operations are in conformity with the policy laid down by the board. The proposal underlines the need for suitably trained and competent staff in these functions.
     
    As mentioned earlier, the DPG stresses on the need to segregate revenue generating functions from control functions to avoid conflicts of interest which may result in costly compromises. 
     
    For achieving all these, the board is required to evolve a code of ethics, conduct and values, and also a whistle-blower policy. The DPG wishes that the board promote a strong culture of adhering to limits and managing risk exposures. 
     
    Feasibility of the Proposals
    While it is difficult to quarrel with the intent of RBI, the paper overlooks certain ground realities in the State-owned banking sector today. These issues are broadly as under:
    a. The power to appoint the directors and their terms of appointment;
    b. The level of autonomy of the board;
    c. The constitution of the committees;
    d. The roles of the designated officials;
    e. The absence of a human resource management (HRM) policy.
     
    Although RBI claims that the new guidelines will be applicable to PSBs, the bank boards have no say in the selection and appointment of any director. Their appointment, terms of appointment and remuneration—all come under the government as the majority shareholder. Even after their appointment, all directors are not treated on par. The nominees of the government and the RBI are always one rung above the rest of the lot; often the MD, the government and RBI directors work in tandem; what they say is taken as gospel by the rest. With four EDs, one MD, two nominees of the government and RBI and two representatives of the employees, independent directors cannot have a majority. As a result, the concept of the autonomy of the board remains as an ideal.
     
    The DPG’s suggestion to make the different committees autonomous also suffers from a practical difficulty. Although the Bank Nationalisation Act (1970) provides for appointing 15 directors other than the MD, the number of so-called independent directors will be only five. As it is, in most large PSB boards, the extant vacancies range from three to eight. Where are the independent directors who are supposed to head each of the three major committees (RMB, ACB and RCB)? The quorum for the meeting of a committee is three. Unless the government quickly fills up the vacancies in the boards, abiding by this proposal is impractical. Further, in PSBs which are listed, there is a provision to appoint shareholder directors. In most case, these directors are sponsored by the institutional shareholders like the Life Insurance Corporation (LIC) which have substantial shareholdings. Their loyalty will be to the institution with whose support they earned their positions on the boards. All these factors raise a huge question mark on the expected autonomy of the directors.
     
    The DPG proposes that the head of each of the key functions - risk management, compliance, internal audit and vigilance must be an official one rank below that of the ED of the bank. S/he is expected to report directly to the respective board committee. In principle it is laudable. But given the hierarchical structure of reporting in PSBs can an executive bypass the ED and the MD to report to the board? Our institutional culture is yet to reach that level of sturdy independence.
     
    HRM Policy Missing
    While it recognises the front-line officials as the first and crucial line of defence, in formulating the RAS, the DPG has not spelt out any role to the people who are responsible to implement it, although they are important stakeholders. As a result, the extant ‘top-down’ approach continues. If the implementing organ of the bank has to be a meaningful line of defence, the guidelines need to be internalised. That sense of internalisation can be developed when there is a two-way communication between the board and the operating staff. 
     
    To work within the framework of a strong risk culture proposed in the DPG, the staff constituting the first line of defence require a new orientation on the implications of the risks. They need adequate training on their role so that they develop skills of decision making and deepen their knowledge of credit appraisal. If this is taken care of, the second and the third lines of defence can discharge their roles effectively. Such an orientation calls for a long-drawn process of HRM. The DPG is silent about this need.
     
    The DPG overlooks the entire gamut of HRM policy on which depends the due discharge of their role. Manpower selection, training, placement, career planning, succession plan, skill and attitude building and the culture of ethics- all these form part of a comprehensive HRM policy. Till now this is entirely regulated by two external agencies- the government which issues periodic guidelines on HR matters and the Indian Banks’ Association which signs agreements with the industry level employee unions.  
     
    Succession and leadership planning have virtually been non-existent in the PSBs for years. This is borne out by the following facts about the top-level positions in many PSBs:
    a. Despite recommendations by several committees, the CEOs have had brief tenures—some of them for as short as 15 months and most of them between two to less than three years. They hold the office till the age of 60. Such short tenures leave very little scope for them to take major policy decisions; even if they take certain initiatives, they would not be there to do the follow up. A new CEO can fix an ambitious goal knowing fully well that achieving it is not his/her look out!
     
    b. Many EDs too have had less than two years’ tenure to superannuate pre-empting their elevation as MDs. 
     
    c. A lot of top executives who constitute the feeder cadre for selection of EDs and MDs have less than five years term left. If they have not put in one year in the feeder cadre and are not left with residuary service of two years, they cannot participate in the process for selection of EDs. Consequently, executives with long experience become unsuitable for higher responsibility because their age is against them.  
     
    This situation is the cumulative result of three government decisions taken over the past 30 years. One, the restriction on recruitment imposed in the 1980s, two, introduction of a voluntary retirement scheme in the beginning of this century and three, after three recent rounds of mergers, easing out surplus staff through exit options.  The combined effect of all such measures is that today PSBs have a severe shortage of experienced and knowledgeable staff at the middle and senior levels. This cannot be corrected through short term measures like lateral recruitment from outside or creating a new tier of top executives like CGMs.  A long-term policy covering training, placement, career progression and performance-incentives and rotation is essential to build up a dynamic, culture-driven workforce.  
     
    Until the government gives full autonomy to the bank boards on matters of HRM, the goals of building an institutional culture of ethics and accountability will remain a pipedream. The employees as important stakeholders can get a sense of involvement if their role is acknowledged both in form and substance. The very fact that the concept of participative management embodied in sections 9 (3)(e) and (f) of BNA is not being followed by the present government is an indicator of the wide gap between the claim and reality in the PSBs.
     
    As of now, given the current preoccupation of the government on more serious issues, it will be optimistic to expect serious governance reforms in the State-owned banks. And they will, sadly, continue to bleed. 
     
     
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    narayansa

    3 weeks ago

    All the HRM policy suggestions and their scant implementation in PSBs are spot on. While it would perhaps be utopian to expect appointment of EDs to be delegated to the Boards by the Govt. it is perhaps feasible to structure about 30 to 40 % of the ED & MDs' remuneration to be performance driven, to be measured by matrices to be decided and evaluated by the respective Boards and the Remuneration and Compensation Committes.(Matrices not to be centrally decided--'one size doesn't fit all') Similar practice to be followed for the GMs directly reporting to the three committees of the Boards
    This would certainly result in the EDs and MD taking the Independent Directors seriously and reduce the overarching importance given only to the Govt and RBI's nominee Directors.
    With this implemented over a certain initial few years without dilution it would gradually transition the PSBs to be more Board driven.
    Ultimately a culture is built by values, policies, practices and precepts.

    REPLY

    sundarbtw

    In Reply to narayansa 2 weeks ago

    Large number of lateral recruits should be done in PSB at higher position. Even joint secretaries in government were appointed with laterals. Here in PSBs, whether sun shines or not, only shuffling within PSBs. RBI is parroting bank capitalisation capitalisation blah. blah. aka put tax payer money into banks. With large migration of business shifting to private sector banks, grand disaster waiting to happen in PSBs.

    RBI Asks ARCs To Deal With Buyers in Line with Ineligibility Criteria under Section 29A of IBC
    The Reserve Bank of India (RBI) on Thursday came up with a Fair Practices Code for asset reconstruction companies (ARC) wherein the central bank has asked the ARCs to deal with prospective buyers in spirit with the Section 29A of the Insolvency and Bankruptcy Code, 2016.
     
    According to the Section 29A of IBC, an insolvent, a willful defaulter or a person who was a promoter or was in the management of the corporate debtor, among other conditions, would not be allowed to bid for the concerned insolvent company.
     
    In order to enhance transparency in the process of sale of secured assets the central bank's code said that invitation for participation in auction shall be publicly solicited, the process should enable participation of as many prospective buyers as possible.
     
    The terms and conditions of such sale may be decided in wider consultation with investors in the security receipts as per SARFAESI Act 2002.
     
    The RBI guidelines said that ARCs shall follow transparent and non-discriminatory practices in acquisition of assets.
     
    "It shall maintain arm's length distance in the pursuit of transparency," it said.
     
    It said that ARCs shall release all securities on repayment of dues or on realisation of the outstanding amount of loan, subject to any legitimate right or lien for any other claim they may have against the borrower.
     
    "If such right of set off is to be exercised, the borrower shall be given notice about the same with full particulars about the remaining claims and the conditions under which ARCs are entitled to retain the securities till the relevant claim is settled/ paid," it said.
     
    RBI said that in the matter of recovery of loans, ARCs shall not resort to harassment of the debtor and would ensure that the staff are adequately trained to deal with customers in an appropriate manner.
     
    Compliance with Fair Practices Code shall be subject to periodic review by the board, it said.
     
    Disclaimer: Information, facts or opinions expressed in this news article are presented as sourced from IANS and do not reflect views of Moneylife and hence Moneylife is not responsible or liable for the same. As a source and news provider, IANS is responsible for accuracy, completeness, suitability and validity of any information in this article.
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