July 12, 2020
Dear Madam Finance Minister, Government of India
You may be aware of RBI Governor’s speech at the 7th SBI Banking & Economics Conclave on July 11, 2020. After all, (technicalities apart) he is the arm of the Government of India looking after Indian financial system on day to day basis. He represents the monetary authority of India. By the way, Monetary Authority along with the Ministry of Finance (Treasury in USA) are the new Gods of economic and financial life of general public, including households and businesses, in any country.
The Mess We Are In
We are in a mess, is to state the obvious. To quote numbers that he shared, “For the five years between 2015-16 and 2019-20, the Government had infused a total of Rs.3.08 lakh crore in public sector banks (PSBs)…The gross NPA ratio… of SCBs stood at 8.3 percent in March 2020, compared to 9.1 percent as on March 2019…”
Who would not know that the infusion of capital in PSBs is an admittance of the (recurring) gaps and holes appearing in the sinking ship and the band-aid approach of the Government to plug it, that has been now a lore of 70+ years, and never worked?
The Gross NPA of SCBs at 8.3 percent are much above international standards. And there is yet another play. I don’t know why the Governor shifted his gear to SCBs when talking about NPAs. A recent study had shown that “PSBs’ NPAs levels exceeded combined NPA levels of private and foreign banks in India after FY-2015. As of March 2019, while SCBs Gross NPA was 9.1 percent as reported by the Governor, the PSBs’ Gross NPAs, as of that date, were 11.6%” (Indian Banks’ High NPAs And Abysmally Low Recovery: Revamp Or Perish, June 5, 2020, businessword.in)
Causes of Weak Financial Institutions
The Governor, conscious of weakness (mess) stated that in order “to strengthen the internal defenses, higher emphasis is now being given on causes of weaknesses than on symptoms. The symptoms of weak banks are usually poor asset quality, lack of profitability, loss of capital, excessive leverage, excessive risk exposure, poor conduct, and liquidity concerns. These different symptoms often emerge together. The causes of weak financial institutions can usually be traced to one or more of the following conditions: inappropriate business model, given the business environment; poor or inappropriate governance and assurance functions; poor decision making by senior management; and misalignment of internal incentive structures with external stakeholder interests.”
The Immediate past RBI governor Dr. Raghuram Rajan had also pointed out the causes for PSB crisis, as follows:
Far too many loans are done without adequate due diligence and without adequate follow-up. Collateral when offered is not perfected, assets given under personal guarantees not tracked, and post loan monitoring of the account can be lax. The lessons of the recent past should be taken seriously, and management practices tightened.
Incidentally, this wisdom of Dr Rajan had come after demitting his office. Believe me, those like me, who have been watching Indian banking system for years, don’t see anything new, at all, in the statements of either of the two, past or present, Governors.
Please note ‘usually’ and ‘one or more of the following causes’ in the statement of the present Governor. That shows that he doesn’t know, for sure, what the causes of weakness actually are, at this time.
As a solution to the existing problem, the RBI governor added that “We are placing special emphasis on the assessment of business model, governance and assurance functions (compliance, risk management and internal audit functions), as these have been the areas of heightened supervisory concern. Supervised entities generally tend to focus more on business aspects even to the detriment of governance aspects and assurance functions. There was also an apparent disconnect between their articulated business strategy and actual business operations. The thrust of the approach, therefore is, to improve the risk, compliance, and governance culture amongst the financial institutions.”
It is like reading a textbook of the early 2000s.
Madam, needless to say, you can’t solve a problem, unless you recognize it, and recognize it correctly, and well in time.
The Problem of PSBs is NPP and not NPAs
The real problem of PSBs is not NPAs. It is Non- Performing People (NPP) at the top.
What PSBs need is a sound performance management systems (PMS), at the C- suite level of PSBs. I am not talking of Memorandum of Understanding (MoU) or Balanced Score Card (BSC) kinds. I am talking of Management Control Systems (MCS) and Individual Responsibility Accounting. Like in USA, the compensation of the top should be linked to meeting or exceeding levels of performance of the top leadership of the benchmark banks, which in India should be private sector or foreign banks. The fear of Central Vigilance Commission (CVC) and political intervention should not be confused with administrative acumen and responsibility of the top management of the PSBs.
Since it is a matter of having appropriate performance management systems in place, it is doable, even with all the mess that we know!
Dr. Sat Parashar, PhD is former Director, IIM Indore. He currently teaches Money and Banking at Rady School of Management, University of California, San Diego. He has been associated with banking in India, Middle East and USA, for more than two decades.