Is the RBI inadvertently protecting poor corporate governance of banks?

Ever since Dr Raghuram Rajan initiated the Asset Quality Review in 2015, the problems bogging the banking system are surfacing from time to time and all well-meaning initiatives of the Government and RBI are failing to yield the necessary results. It looks like the banking system has reached a point of no return. How could they reach this low level ? It is not easy to pinpoint a specific period when banks started losing focus, but the sad demise of the Development Finance Institutions (DFIs) has a role to play. The scheduled banks who were until then predominantly dealing with retail and working capital loans, having smaller moratoriums and adequate security coverage were asked to reinvent the wheel and take exposure to projects having longer gestations and breakeven periods with neither the necessary expertise nor the balance sheet support, at a time when the focus of the government was on infrastructure development.

The RBI has been at the receiving end for their laxity in supervising these banks. Are they really lax? RBI conducts the financial inspection of banks annually. These inspections are elaborate and when conducted diligently, reveal the failures in the governance process and the commitment of management to ethical business practices. But the reports of these inspections are confidential. They are so confidential that even within the bank, the access is available only to the senior management. Recently Girish Mittal, the RTI activist ,has managed to access the RBI inspection reports of 5 banks (SBI, ICICI, Axis , HDFC and Bank of Baroda) under the RTI after a legal battle. In one of those cases, the Supreme court has observed that “RBI is not in any fiduciary relationship with the banks and that RBI has a statutory duty to uphold the interest of the public at large”.

One of the reports is that of Bank of Baroda for the year 2015-16. This means it covers the period before the merger of Vijaya Bank and Dena Bank with Bank of Baroda in 2019.The report reveals that the Regulator had detected deficiencies in corporate governance. The key takeaway being that “the bank was very poorly governed at all levels, showed scant regard to processes and controls that are required while managing public funds”. This is contrary to what the Bank has projected to its various stakeholders through its Annual reports and management commentaries. It is also contrary to what the Statutory Auditors have certified. The bank Management has the priority of keeping all the stakeholders happy, which makes them resort to earnings management, using tools like evergreening of loans and sweeping the mess under the carpet. The auditors, being subservient to these management, reluctantly tow the line, reinforcing the criticism of ‘rubber stamps’ being leveled against them.

Now while RBI has been able to detect these deficiencies in their annual inspections ( which is contrary to calling them lax), the real problem lies in keeping the RBI inspection reports confidential. So the real allegation against RBI as the nodal regulator is not that they failed to detect and arrest the problem in time, but that this information is not shared with the other stakeholders. Because of this lack of transparency, the public (retail investors or the depositors) are not able to take an informed view on how the banks are performing. They are being allowed to be misled by incorrect statements of management and never get to know the true picture of the mess the bank is actually in. In the instant case, one of the findings that would have made the public sit up and take notice would have been “the bank is using a parallel system (other than the core banking) to monitor NPAs”. Obviously the intention of having such a system is questionable. Had this fact been disclosed, one could have easily concluded that such a system can help the bank to understate the NPAs and the provisioning, thereby inflating the profits.

In defense the Regulator could argue that this can lead to a systemic risk – the dominos effect -which they are religiously required to hedge. Moreover effective from April 2019, banks have been mandated to disclose divergences in their annual financial statements if either, the additional NPA provisioning assessed by RBI exceeds 10% of the reported profit before provisions and contingencies for the reference period or the additional gross NPAs identified exceed 15% of the published incremental gross NPAs . A good beginning no doubt. But as the government decides to privatise banks, transparency is the least thing the retail investors and depositors can expect from the management of banks and the RBI. It is their hard earned money after all. So is it unreasonable to expect the RBI to prompt more transparency from the management of banks?

The RBI must on an ongoing basis, release the bank inspection reports to the general public and encourage debate on the challenges facing the banking system. Such transparent reporting will help in restoring the public trust in the banking system. The present opaque system of RBI audits uncovering operational discrepancies while statutory auditors and bank managements sweeping them away must end for Indian banking to be ready for the new era of fintech disruptions.

from

Meera L. B. AranhaProfessor & Chairperson - Banking and Financial Services, T A Pai Management Institute, Manipal