Despite a slowdown in loan growth, the September quarter has been quite interesting for the Indian banking industry. Banks are not aggressive in pushing home, automobile and consumer loans, but approvals for infrastructure loan proposals are rising and when such loans are disbursed, banks’ loan book will grow. The net interest margin, or the difference between the cost of funds and income on loans, a key indicator of bank profitability, has also increased at most banks as they have redeemed high-cost bulk deposits and cut the rates on fresh deposits. One area of concern is the quality of assets but there are no visible signs of deterioration as yet as the regulator has allowed banks to restructure loans that borrowers were not in a position to repay when economic growth had slowed.
A nasty surprise among public sector banks, which make up roughly three-fourths of the industry’s assets, has been Bank of India. Its net profit has fallen from Rs762.86 crore in September 2008 to Rs323.34 crore. The main reason behind the decline has been higher provisions for bad loans—Rs602.13 crore against Rs286.75 crore. It had to set aside more money to take care of rising bad loans. Overall, its gross bad assets have risen from Rs1,978 crore a year ago to Rs3,920 crore in September and net bad loans, or the bad assets net of provisions, have risen from Rs608 crore to Rs1,605 crore. The bank’s gross bad loans, as a percentage of its total loans, is now 2.61% (up from 1.53% a year ago) and net bad loans 1.08% (up from 0.48% a year ago). Bank of India would have been able to absorb the shock of higher provisions for bad assets had its overall performance been good. But that has not been the case. There has hardly been any growth in its interest income as well as fee income and, as a result of this, its operating profit, which is calculated before provisions are made and is a key parameter of judging a bank’s efficiency, has fallen from Rs1,215 crore to Rs1,206 crore.
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Why has this happened? Had the reason been the economic slowdown, all other banks would have been equally affected. So one should not blame the economy for this bank’s bad performance.
One reason could be the change of guards at the bank. Its former chairman T.S. Narayanasami retired on 31 May. Alok Misra, who was till recently heading the Delhi-based Oriental Bank of Commerce, now heads Bank of India. An analysis done by a banking consultant shows there is a correlation between a public sector bank’s performance and the retirement of its chairman. This consultant, who does not want to be named as it advises many banks on their business strategy, has reviewed the quarterly performance of public sector banks in the past eight years and the results are quite startling. In six out of 10 cases, there was a sharp drop in a bank’s net profit and rise in its bad assets after a change of leadership. Interestingly, this trend is evident in those cases where the chairman retires, but when the leader leaves one bank for another bank—normally the chairman of a relatively smaller bank gets promoted to head a relatively bigger bank after a few years—the balance sheet does not show any strain.
There are two reasons behind this trend. One, there is a tendency by the outgoing CEO to inflate profits as the leader always wants to leave the organization on a happy note. It’s like a cricketer wanting to score a century in his last innings (in the case of a batsman) or take a handful of wickets (in the case of a bowler). Two, the new CEO normally wants to begin with a clean slate.
Indeed, the quality of assets is seldom the headache of an outgoing chairman. His focus is on balance sheet expansion (higher loan growth earns higher interest income) and profits and in the process the bank may end up piling bad assets that eats into its profits in the future. Similarly, the new chairman often wants to tell the world, “I’m here holding the can” and embarks on a clean-up drive immediately after taking up the assignment. It is another matter that the incumbent retires one day and may repeat his predecessor’s exercise. I call this the saas-bahu syndrome in Indian banking. Many new brides feel unhappy about the way they are treated by their mothers-in-law, but they end up doing the same thing to their own daughters-in-law!
How can one stop this practice? Since the salary of the CEOs of public sector banks is not linked to the performance of the banks, one should not presume that the focus on balance sheet and profit growth is linked to greed. Indeed, they earn a performance-linked incentive, but that’s too small an amount and is linked not to profit alone but various other parameters. Bankers often do this to protect their reputation. If they sign off on a good note, they are assured of a post-retirement assignment at some other government-run organizations. One way of tackling this phenomenon could be not offering any post-retirement job to any retired banker till such time as the regulator is convinced that the bank’s health had not been compromised for higher profit. The regulator also needs to keep a hawk eye on the auditors of those banks that show wild fluctuations in net profit.
Tamal Bandyopadhyay keeps a close eye on all things banking from his perch as a deputy managing editor of Mint. Please email comments to email@example.com