Banks face big hit from pension costs

People familiar with the development said the burden on the public sector banking industry could be as much as around Rs16,000 crore. The collective net profit of these banks in 2006-07 is estimated to be around Rs22,000 crore.

The liability could go up further and cross Rs42,000 crore if the industry is forced to offer pensions to all employees, as being asked for by bank trade unions who are set to end their temporary truce on this matter and reaffirm their pension demands as early as 31 May.

The finance ministry has already called for information from each bank and the Indian Banks’ Association (IBA), the main bankers’ body in India, is collating the figures.

“It will vary from bank to bank, depending on their work force and past provisioning," said a finance ministry official who did not wish to be named.

The banking community is playing down the impact. And, for obvious reasons.

“It is price-sensitive information and will have serious implications. Why put the fear in investors’ mind?" asks V.P. Shetty, chairman of IBA and head of the Industrial Development Bank of India (IDBI).

New private banks such as ICICI Bank Ltd, HDFC Bank Ltd and others will not be affected by the new accounting norm as they have a relatively younger workforce and with a very high attrition rate, not too many employees opt for defined retirement benefits. “Most of our employees prefer instant cash instead of deferred benefits and accordingly, we structure their pay packets," says an executive of a large private bank who does not wish to be identified.

Currently, about 50% of public sector bank employees get pensions under a settlement brokered by IBA in October 1993.

The Rs16,000 crore problem is the result of a difference in the assumptions that the banks have made while calculating the retirement benefits of their employees and the norms that the Institute of Chartered Accountants of India (ICAI) wants them to follow.

Every year, each of these banks provide money to cover the retirement benefits of their employees calculating their basic pay, dearness allowance, past service and years left to retire as well as the mortality rates. The calculation, done by actuaries, varies from bank to bank.

The new ICAI-backed norms have standardized these assumptions and mandate that banks and corporations must calculate the last salary that will be drawn by an employee and provide for pension and gratuity liability on that basis. This will then have to be certified by a professional actuary. The critical component in the new norm is the projected salary growth that needs to be taken into account to determine the pension liability.

The new norm, known as Accounting Standard 15 (AS15), notified in December 2006, was to come into effect from the new financial year beginning 1 April.

However, strong lobbying by different quarters has been able to postpone it by one year. The banks have also moved ICAI seeking its nod to make provisions in phases over next five years.

“It will come into effect from April 2007 and banks are likely to be allowed to make provisions over a period of five years," hopes G. Sankaranarayanan, senior vice-president and chief adviser, personnel, IBA.

IDBI’s Shetty says the industry has not yet assessed the full impact and banks are working out their liabilities.

He also rules out any possibility of accepting the trade unions’ demand for pension for more employees “in the present format."

“Even if the banks are to provide for more funds, it will not affect their profitability as they will draw down from their reserves (to meet the requirement)," Shetty says. However, he admits that weak banks that do not have the cushion of huge reserves will be affected.

An international consultant who advises banks on organizational restructuring but doesn’t want to be named says that, either way, the banks are in for a hit.

“If they want to protect their profitability and provide for the post-retirement benefits for their employees by drawing down from their reserves, they will end up eroding their capital," he says.

Meanwhile, this is also a time when the banks need more capital to support their credit growth as well as meet the requirement of international banking guidelines under Basel II norms for reducing their risk exposure.

The Tier I capital of the public sector banking industry, consisting of equity capital and reserves, was to the tune of Rs1,05,867 crore. About 40% of this will be eroded if the banks decide to offer pension to all employees.

Canara Bank chairman M.B. Rao says roughly 50% of his bank’s net profit this year will be needed to bridge the gap.

“I have about 19,000 employees and need to make additional provision of around Rs300 crore which is less than 50% of my net profit. If I am allowed to stagger this for over five years, the impact will be much less," says A.C. Mahajan, the head of the Kolkata-based Allahabad Bank.

Gautam Nayak, partner, Contractor, Nayak & Kishnadwala, a chartered accountants firm, says the liability will be substantial though he said it is difficult to quantify the amount unless the balance sheets of all public sector banks are audited.

Employees of the State Bank of India, the country’s largest commercial bank employing about two lakh persons, get three retirement benefits—provident fund, gratuity and pension. The other public sector bank employees, however, get two benefits—gratuity and provident fund or pension.

Following the 1993 settlement, these employees were given a one-time opportunity to opt for pension in lieu of the company’s contribution to their provident fund. Normally, both the employer and the employee contribute 10% each of the basic salary of an employee to the provident fund kitty.

The scheme was notified in September 1995 and was put in place in January 1996. Even those employees who had retired on or after 1 January 1986 could opt for pension if they were willing to return the company’s contribution to provident fund along with interest. About half of the seven lakh employees of these banks and thousands of retired employees opted for pension.

However, 10% of their basic pay, the company contribution to their provident fund that was diverted to create the pension corpus, is not enough to take care of their pension payout.

An IBA calculation made in 2000 had found that 26.5% of an employee’s basic pay could take care of the pension payout which means there was a 16.5% gap in the funds flow to the pension corpus.

By 2005, the gap widened further to 20% as about 30% of their basic could have covered the actual pension burden instead of 10%. For those who had already retired, the gap was slightly more, at around 22%. Since then, the gap has widened further.

If all employees are offered pension, as the trade unions have been demanding, the liability will go up by at least Rs26,000 crore. According to Sankaranarayanan of IBA, close to three lakh employees did not opt for pension. Their average age is now 49 and average basic pay Rs16,000.

K.K. Nair, general secretary of the Indian National Bank Officers’ Congress, a constituent of the United Forum of Bank Unions that has sought the intervention of the Prime Minister’s Office for pension benefit to bank employees, dubs the IBA calculation as exaggerated.

“We have appointed a few actuaries to get a fix on it. If required, the employees are willing to bear part of the burden," Nair says.

An employee’s pension is 50% of her last drawn basic salary and the dearness allowance (DA). For instance, a public sector bank general manager now earns a basic pay of Rs32,000 and about 27% of it in the form of dearness allowance. So, a general manager’s pension will be about Rs22,000 (50% of basic pay plus DA) if she retires today. An employee is entitled to full pension after 33 years of service. In case one seeks a voluntary retirement, one can still get full pension if one has completed 28 years of service.

Apart from pension benefits, the AS15 also mandates banks to provide for other retirement benefits such as leave encashment benefits. A bank employee can encash as much as 240 days’ leave. Most banks have provided for this.

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