RBI Governor Warns Banks against Using 'Smart Accounting' To Artificially Boost Financial Performance
Moneylife Digital Team 29 May 2023
While calling directors to ensure the integrity of financial statements published by the bank, Shaktikanta Das, governor of the Reserve Bank of India (RBI), also warned lenders to refrain from adopting so-called smart accounting methods to artificially boost the bank's financial performance.
Speaking at the conference of directors of banks organised by RBI for public sector banks (PSBs), the governor said, "The board of directors, especially the audit committee of the board (ACB), should bestow close attention on the accounting policies followed by the banks and implement preventive controls to preclude smart or aggressive accounting practices. The board or the ACB should engage with the statutory central auditors of the bank to ensure that their financial reporting is transparent and prudent."
During the course of the supervisory process, Mr Das says, certain instances of using innovative ways to conceal the real status of stressed loans have also been noticed. "To mention a few, such methods include bringing two lenders together to evergreen each other's loans by sale and buyback of loans or debt instruments; good borrowers being persuaded to enter into structured deals with a stressed borrower to conceal the stress; use of internal or office accounts to adjust borrower's repayment obligations; renewal of loans or disbursement of new or additional loans to the stressed borrower or related entities closer to the repayment date of the earlier loans; and similar other methods." 
"We have also come across a few examples where, after being pointed out by the regulator, one method of evergreening (w)as replaced by another method. Such practices beg the question as to whose interest such smart methods serve. I have mentioned these instances to sensitise all of you to watch such practices," the RBI governor says.
In his inaugural speech, Mr Das also stressed on effective corporate governance in PSBs. According to him, the safety and soundness of the banking system rely critically on effective corporate governance which helps to build an environment of trust, long-term stability and business integrity of banks.
RBI issued guidelines listing seven critical themes that should be discussed at the board meetings. These themes are business strategy, financial reports and their integrity, risk, compliance, customer protection, financial inclusion and human resources. 
However, Mr Das says, "It is a matter of concern that despite these guidelines on corporate governance, we have come across gaps in governance of certain banks, with the potential to cause some degree of volatility in the banking sector. While these gaps have been mitigated, it is necessary that boards and the management do not allow such gaps to creep in." 
"Governance frameworks can be pictured as a complex mesh of nuts and bolts holding the financial pillars of capital, assets, deposits and investments in place and keeping the structure of the bank upright. Raising financial resources would not be a constraint for banks with robust governance frameworks as they can command a governance premium. This premium in turn will be driven by quality of leadership at the top," he added.   
In his speech, the RBI governor also expressed concerns over gaps and material inaccuracies in the information provided to bank boards. Further, he says, the agenda notes shared with the boards for review do not capture all the relevant information, making their review either ineffective or partially effective. 
"We have come across instances of agenda papers not being circulated well in advance. There were also instances of only PowerPoint presentations being circulated as agenda notes. These PowerPoint presentations are like a guided tour, and directors should clearly look beyond a guided tour," he says.
According to Mr Das, it is the responsibility of the senior management to provide material information to the board in a timely, accurate and understandable manner so that the boards can make informed decisions. "Care should be taken to avoid voluminous notes and information overwhelming the directors with superfluous data. On the other hand, the board also has a responsibility to seek as much relevant information as required for it to satisfactorily reach a decision."
The RBI governor also discussed the issue of compensation structure in banks. He says, " A compensation structure which does not distinguish between prudent risk-taking and excessive risk-taking often results in a culture of indifference towards risk-taking. Banks need to rethink their internal accountability structures to ensure that prudent risk-taking is rewarded and imprudent decisions are discouraged. Employees cannot be rewarded for increasing short-term profits without adequate recognition of the risks and long-term consequences."
M. T. Chiddarwar
4 months ago
Smart or creative accounting was pioneered at ICICI by Mr K V Kamat, then it was picked up by other Financial Institutions and banks. Then everybody suffered the consequences.
4 months ago
There is much to be written about the quality of the Board of a bank as well. Most often, the Boards are packed with people who have very little knowledge of banking . Merit is overlooked and favoritism takes over. Added to this, unscrupulous bankers who spoil things . Result is a concoction of dangerous proportions.
4 months ago
Yes ,Governor's warning is correct as there are anomalies in softwares of the bank.RBI must ask banks about complaint regarding charges and interest in accounts and these should be taken seriously.
Accountability of Directors on board be fixed for big accounts sanctioned by them.You will agree in banks where committed are formed for sanction ,there is no responsibility of any one.This is very serious matter and needs to be examined
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