Monday, September 15, 2014

Governance of Banking Sector- Challenging Issues

The banking sector is going through a testing time. On one hand non- performing assets have risen significantly and on the other there are serious allegations of fraud and corruption embalming many banks. RBI and previous Government need to owe this responsibility. Their decision to delegate the responsibility of appointment of Statutory Auditors and Bank Branch Auditors in favour of bank managements, withdrawal of Audit for 5 years in more than 60% branches, shifting independent concurrent Audit to internal staff working under direction of top management, non-revision of Audit fee for 7 years, regular criticism and sidestepping of independent Directors and middle management, all this has resulted in adverse impact on internal control mechanism in banks. RBI's NPA classification being rule based, could not address challenges of economic downturn and large number of adverse economic factors impacting the working of key sectors. The Indian industry and businesses need a positive policy and regulatory support.

The role of external credit rating agencies in India has been far from satisfactory. Even in U.S. Lehman Brothers crisis, the credit rating was completely misled by technical factors. The Indian banks should rely only on internal credit rating system, which are quite robust. The increasing reliance on external credit rating agencies is also responsible for non- identification of problem areas at right time. The approach of credit rating agencies lack transparency and is based only on technical parameters, rather than real credibility of the borrower.

Independent credit ratings do not add any value and only cause unnecessary hardship and credit delays. The Government may consider a periodical detailed independent credit appraisal for loans beyond Rs. 100 crore. The credit appraisal report need to be detailed rather than a single digit credit rating number, providing no rational support.
The Govt. needs to take serious concrete actions in following important areas of Governance in the banking sector:

  • The selection process of CMD and ED of PSU banks needs a professional approach and it cannot be left to RBI and Department of Banking. The Quality, skill and capability of the top management is very crucial.
  • The Executive Directors need adequate board level experience before they can be considered for the top position. The current practice of selections or promotions based on seniority and clean track record alone may not be enough.
  • The PSU banks CMD contenders also need to present their long term vision and approach in an open recruitment process. The actual performance of CMDs and EDs need a periodical detailed hot review by an independent professional group under guidance of the Finance Minister.
  • The organizational structure and the middle management consisting of General Manager and Deputy General Manager need to be empowered to ensure proper internal control and to restrict too much concentration of power on top.
  • The Board of Directors and Audit Committee need to spend adequate time in planning, organizing and control. The current practice of 1 hour to 2 hours meeting, without any advance agenda, briefing, MIS or regular reporting are highly inadequate and actually leave the decision making only in the hands of top management, without adequate effort Board effort to monitor and supervise the performance.
  • The independent directors need to be carefully selected and adequately remunerated for time spent and responsibility taken. The full time functionaries need to take main responsibility. The Government and RBI representatives on the Board need to play more responsible and active role
  • A 360 degree feedback on performance of top management can be taken from middle level management, borrowers and other stake holders.
  • The banks need to develop internal strength to understand and monitor sector specific issues.
  • The banking guidelines on purpose and uses of funds need to be self-regulated by the borrower. The concept of diversion of funds need modification and to be more practical to provide adequate flexibility and to regulate manipulation. Diversion cannot be equated to siphoning.
  • Non-Core Area: The banks may consider dis-investment in non-core areas to other PSU's, to provide adequate capital.
  • The sale of non-performing assets to Asset Reconstruction Companies has brought in fraudulent and corrupt practices. Existing ARCs have not contributed positively for revival of business and have concentrated on One Time Settlement or mortgaged assets acquisition. It may be important for the government to assign all non-performing assets at their full book value to 100% government/PSU owned Asset Reconstruction Companies. This will comprehensively improve focus on NPA's which can be revived and disposal of the rest. The focus and emphasis being on revival of a positive and developmental attitude.
  • Professional Inter mediation: In the current atmosphere, serious discussions are being made in regulatory quarters to eradicate professional consultants and intermediaries. The individual and corporate consultants play a very important role in planning, techno-economic feasibility study, development of new financial products and specially designed financial structure to help the entrepreneurial borrowers as well as the banks. The corrupt attitude of few miscreants need not be generalized as it may severally impact the working of the entire financial market and may unnecessarily eradicate very important professional input. The role of corporate players and bank entities is much larger in syndication of loans.
  • NPA Review committee: The appointment of a High Powered 4 Member Review Committee by IBA, at the  behest of RBI, consisting of ICSI, CMA, Valuers and Engineers will not bring any result. The Institute of Chartered Accountants has rightly decided to not to sponsor a member. The monitoring of potential NPA has to be undertaken by the banks individually and as a group/consortium.
  • Fear Psychosis: It is important to eradicate fear psychosis of a potential CBI or Vigilance inquiry in case a particular loan goes bad. The top management and middle management business decisions need to be respected, except in case of cheating.
  • The private sector banks and PSU banks cannot be compared as the PSU banks significantly contributed to education sector, small scale sector, agricultural sector and financial inclusion.
  • Willful Defaulters: The banks need to be extra careful while categorizing delays and non- payments as willful default. The non-performing assets have mainly risen due to poor economic growth, business slow down and external factors including lack of coal linkages, cancellation of telecom licenses, delay in implementation in power sector and road sector projects, untimely payment by state level electricity companies and other reasons beyond control of management. 

NHAI, ERC: The negative role of National Highway Authority of India, Central and State Level Electricity Regulatory Commission, 2G scam, poor mechanism to resolve the disputes/ issues during last few years and lack of Government decisions have further contributed to the problems. A genuine business failure or an erroneous business decisions cannot be categorized as willful default. There is a need to inculcate a judicial process in the bank, with an opportunity of being heard to ensure that genuine delays or non- payments arising out of reasons beyond control of the management or promoter are not categorized as willful default. A positive attitude is necessary to revive NPA's. The developmental role of PSU's cannot be replaced by a peculiar money lender attitude. The failure to comply with bank's terms, conditions, requirements or procedures cannot per se be treated as fraudulent or case of cheating. SEBI decision to ban capital market support to willful defaulters has to be applied only to proven scamsters or cheaters. The Indian businesses deserve a fair and positive treatment.

  • Adequate Capitalization: The PSU banks need to be adequately capitalised by channelising a part of Rs 200 Thousand crores investible surplus available with selected public sector undertakings. A comprehensive strategy to bring back anup beat sentiment in the banking sector is needed.
  • Regulatory Aspects: A comprehensive review of regulatory mechanism, suiting to Indian need will be very important. The RBI and Government should not provide special and additional facilities to foreign banks for creating Indian subsidiaries or to take over existing Indian banks. It is important to provide adequate strengths to existing Indian banks and to promote a liberal licensing for new Indian banks fully supported by government and RBI policy, so that they can compete with large mega international banks. The conditions imposed on Indian banks cannot be stricter than imposed on foreign banks. Our Public Sector banks and Private sector banks are very strong. It is important to provide for a detailed internal and external Audit by Auditors appointed by independent committee on strict parameters with pre- determined fee, scope, coverage and reporting requirements to strengthen controls and financial discipline.

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