Bank recapitalization: The mockery of MoUs and statements of intent
Public sector banks (PSBs) are “instrumentalities of the state”; managing them efficiently to promote economic development and further public interest calls for efficient public administration and committed public service with due accountability. For ensuring “efficiency” in management of PSBs, two sets of tools were used by the administrative department, the department of financial services (DFS): the statements of intent (SoI) and memorandum of understanding (MoU). Both were supposed to play a critical role in monitoring capital infusion in PSBs, but a deeper look into how both these instruments were used gives us a sense of the quality of governance in PSBs, if nothing else.
The mechanism of SoI on annual goals to monitor the performance of PSBs was introduced on the directions of the finance ministry in June 2005. A set of performance parameters was defined and targets were set for PSBs against these parameters. The SoI parameters have been revisited and redrafted on several occasions with amendments on 23 April 2010, 21 October 2011 and 20 May 2012.
Following the May 2012 amendment, there were 44 SoI parameters which were to be monitored by DFS. Besides being a tool for monitoring the performance of PSBs, the SOIs were also used to incentivize their top management when the SoI targets were achieved. However, a closer look suggests that such monitoring became a routine and tame affair linked only to the incentives of top management and not for any meaningful exercise to ensure efficiency in capital management.
Only in one year (2010-11) out of the nine years (2008-17) were conditions stipulated in the sanctions that were issued for infusion of capital in PSBs. No such conditions were on record for the other years. Incidentally, the SoI parameters were used as an instrument for efficient management of PSBs and not for ensuring either capital conservation or capital efficiency. For instance, the targets stipulated against specific parameters at the time of sanction of capital in 2010-11 were significantly different from the targets set for the same parameters in the SoI for the same period in case of five PSBs.
The SoI targets were less stringent than the targets associated with the sanction orders; records show that there were little follow-up and monitoring when actual achievements of PSBs lagged behind or were poor compared to the SoI targets. One wonders whether incorporation of the conditions set in the sanction of capital orders was actually monitored by DFS. For the sake of records, the SoI, however, seems to have been reviewed regularly by the banks themselves as well as DFS. One tends to conclude that over the years, despite good intentions to “control” the management of PSBs, the SoI became a routine annual management tool on paper with little or no relevance to the process of capital infusion.
In February-March 2012, DFS introduced the system of MoU with PSBs to ensure that they lay down a firm plan for long-term business development and performance enhancement, and relate the same to their capital requirement. The MoU, signed by the PSBs and DFS, consists of a set of agreed targets that the PSBs are expected to achieve, which would form the basis for future capital infusion by the government. The aim of the MoU was to achieve optimum utilization of scarce capital funds, with PSBs focusing on improving their efficiency simultaneously with the infusion of capital.
The practices followed in preparation, finalization and monitoring of MoUs by DFS are not the best and, as records show, MoUs had never been the basis for capital infusion in PSBs. A look at the MoUs also makes it clear that the targets set against some of these parameters were decreasing year-on-year, indicating that lower efficiency was being targeted.
One can take the case of CASA (current account and savings account), the cheapest source of funds for banks, which boost profits. State Bank of India’s (SBI’s) actual CASA was 48.66% in 2010-11 but the target was set at a lower 45% for all the years from 2011-12 to 2014-15. For Kolkata-based United Bank of India, the CASA targets were reduced progressively each year from 39% in 2011-12 to 37% in 2014-15.
For IDBI Bank Ltd, while the actual cost-to-income ratio for 2010-11 was 35.15%, the target for 2011-12 allowed costs to go up substantially as it was pegged at 39.4%. This means the target set for the future was lower than the current achievement. The targeted cost-to-income ratio for Punjab National Bank was allowed to go up progressively between 2011-12 and 2014-15.
For certain PSBs such as Andhra Bank and Allahabad Bank, specific targets were set for all components of the Reserve Bank of India ratings but in case of some PSBs, such targeting was waived. For example, in the case of Bank of Maharashtra, Bank of Baroda, Bank of India and Indian Bank, the targets were evasive and non-specific (“Shall improve upon existing rating on all parameters, particularly on asset quality, management, systems and control”).
In the cases of implementation of MoUs, there were inordinate delays and dithering. As per directions of DFS, the MoUs were to be finalized by 30 November 2011. However, the MoUs were signed in February-March 2012—a delay of nearly three months from the stipulated date. And, surprisingly, while the MoUs were signed as late as March 2012, they included the targets to be achieved by 31 March 2012. Naturally, the status of achievement on targets for 2011-12 was a foregone conclusion. In fact, the MoUs between SBI and its associate banks—State Bank of Bikaner and Jaipur, State Bank of Travancore, State Bank of Mysore, State Bank of Hyderabad and State Bank of Patiala—for 2011-12 were signed after the fiscal year ended, in the first week of April 2012.
The finance ministry can always defend the delay saying it had started discussions with the banks immediately after the draft MoUs were sent to them which indicated the figures and hence even though the signing was delayed for various reasons, the targets were known to the ministry. However, the figures in draft MoUs (circulated to all PSBs in October 2011) were significantly different from the actual MoUs that were signed (February-March 2012), which again points to rampant discretion and ad hocism on policy issues.
There was a wide variation and discretion in application of MoU terms and conditions also. The MoUs were to be valid for a period of five years. However, with the exception of Central Bank of India (for which targets were fixed from 2012-13 to 2016-17), for all other PSBs, the signed MoUs contained targets to be achieved only till 31 March 2015. It seems DFS entered into MoUs initially for a period of three years and the targets were given until 2015. These targets were supposedly laying the road map towards achievement of the final or ultimate targets by 2017. In other words, the targets given to the banks to be achieved by 2015 were interim targets, preparing them for the final target in 2017.
The targets for the three years between 2011-12 and 2014-15 were fixed in the MoUs signed in February-March 2012 but the SoI targets were fixed annually. One would expect that there are enough efforts to synchronize the targets between these two oversight mechanism. But in reality, it was observed that out of the 44 parameters under the SoI, five parameters were common with those in the MoU. They were CASA, RoA (return on assets), cost-to-income ratio, net profit per employee and ratio of staff in branches to total staff. There was a significant variation between targets in the SoIs and MoUs for the same parameter. For instance, in case of CASA, the maximum difference was 18%, for RoA 1.37%, cost-to-income ratio 21.3% and for net profit per employee Rs10.15 lakh.
There was ad hocism in monitoring as well. The banks were to submit a progress report every quarter on the performance of the parameters stipulated in the MoUs. Going by this, 273 progress reports were to be received from 21 PSBs (one from each bank for the fourth quarter of 2011-12, four from each lender for each fiscal year from 2012-13 to 2014-15) but only 21 (for the fourth quarter of 2011-12 only) progress reports were received from PSBs. Do we need more proof to reflect on the quality of PSB monitoring and capital management?
This is the last of a three-part series on bank recapitalization.
Tamal Bandyopadhyay, a consulting editor at Mint, is adviser to Bandhan Bank. His latest book is From Lehman to Demonetization: A Decade of Disruptions, Reforms and Misadventures.
Achintan Bhattacharya is a former civil servant and former director of the National Institute of Bank Management, Pune.