Home / Opinion / What ails (some of) India’s private banks?

The votaries of private banks so far have been enjoying a voyeuristic pleasure watching some of India’s public sector banks (PSBs) being stripped naked. The PSBs’ bad assets have been zooming for quite some time; growing incidents of fraud added to their woes. Against this backdrop, the clamour for privatization has been getting louder and analysts are busy calculating how much and how fast the share of PSBs in banking assets will get eroded. And, of course, almost everybody has been discussing corporate governance, or the lack of it, in the PSBs, which roughly have a 70% market share.

The problems have spilled over to the private sector now. The Reserve Bank of India (RBI), it seems, does not have much confidence in the ability of the chief executive officer (CEO) of a large private bank. The boss of an even larger private bank has been mired in controversy for allegedly giving loan to a corporate house, which has business links with the spouse of the CEO. The brother-in-law of the CEO is also allegedly involved in restructuring foreign currency debt given by this bank, along with others.

In the last week of July 2017, Shikha Sharma was reappointed by the board of Axis Bank Ltd, India’s third largest private bank by assets, as its CEO and managing director, for another term of three years, beginning June 2018. The announcement, almost a year before her term comes to an end, was to silence endless media speculation on Sharma moving out of the bank, which she has been heading since June 2009.

However, RBI is not convinced. Considering the performance of the bank, its quality of assets and under-reporting of bad loans—the divergence between the bank’s disclosed non-performing assets (NPAs) and the regulator’s assessment, which has led to under-provisioning—RBI has asked the bank’s board to reconsider the decision. Now, it seems, Sharma will be at the helm for a year till her successor is identified.

Incidentally, a few weeks before the board took the decision to reappoint Sharma for her fourth term, the bank had hired Egon Zehnder, a global executive search and talent strategy firm, to look for her successor. Probably the mandate for Egon Zehnder was “market scan", and since that did not yield a satisfactory result, the board opted for “continuity".

While RBI’s reservation on the recommendation of the Axis Bank board is a reflection on the bank’s performance, the issue with Chanda Kochhar, managing director and CEO of India’s second largest private bank ICICI Bank Ltd, is different. It revolves around her persona.

There has been extensive media coverage on how the banker allegedly used her position to favour her husband and brother-in-law and how several investigating agencies are following the trail. The ICICI Bank board, led by its chairman M.K. Sharma, is backing her to the hilt. So does N. Vaghul, a former chairman of the group. The bank’s communication division has also been busy sending denials to the “misleading" reports and clarifying that “the brother of a husband does not fall within the definition of a ‘relative’ under the Companies Act…and, hence, there is no requirement of any disclosure of such a relationship…"

I don’t believe in trial by media. A school of thought believes that a certain quarter has been working against Kochhar, and her detractors have been successful in spoiling the public issue of ICICI Bank’s investment banking arm by orchestrating the canard against her. The noise on Kochhar is so loud that, barring the investigating agencies, hardly anybody is talking about fraud-hit Punjab National Bank and the fugitive billionaire, Nirav Modi, these days.

If indeed there is a vicious campaign against Kochhar, why isn’t the bank taking legal action to stop “the insinuation of conflict of interest", which the bank claims is “totally baseless and mala fide in intent"?

Alongside, the board of ICICI Bank should order a forensic audit by a reputed agency to silence the critics once and for all. After all, the “campaign" against Kochhar has been there for about two years now. Incidentally, Vaghul, while saying that Kochhar can never indulge in nepotism, agreed that the bank’s board could have considered a deeper external inquiry into the matter in the interest of good governance.

Recently, after The Wall Street Journal reported the alleged misuse of company assets by WPP Plc CEO Martin Sorrell, the board of the world’s largest advertising company has hired a law firm to look into the allegations; Sorrell, on his part, has rejected the allegations, but recognized that the company has to investigate.

Whatever the case may be, both the banking regulator and the government need to handle the ICICI Bank controversy with extreme sensitivity. Otherwise, this will create a crisis of confidence. The PSBs have already been in bad shape with 11 out of the 21 of them not functioning fully, bound by the so-called prompt corrective action framework of RBI. Depositors’ money will remain safe both in public as well as in private banks, but a shaky banking sector will not be able to support economic growth when the momentum is picking up.

Having said this, let’s also accept the fact that not all private banks can boast of an impeccable track record of corporate governance and ethical standard. The following are some of the areas where the rot is pretty evident:

NPA management: A few private banks manage their bad assets deftly. It is being done by giving fresh loans to an arm of a corporation which is on the verge of turning into a defaulter. This practice of “ever-greening" is rampant in some PSBs, too, but private banks are more innovative. At times, they give a loan to an entirely different company with an understanding that the firm will pass on the money to rescue a defaulter. This art was first perfected by a large private bank and emulated by a few others.

There is another ingenious way of bad loan management. When a string of accounts are on the verge of turning bad, typically a pool of debt is created covering all, gets rated by a not-so-reputed rating agency, and is sold to relatively smaller banks, including cooperative banks. This practice of down-selling or palming off of bad loan has been invented by a private bank which enjoys the blessings of a politician, who also wields enormous influence on some of the cooperative banks.

Yet another clever way of managing bad assets is sanctioning two loans at the same time. While the first loan is disbursed immediately, the disbursement of the second loan is typically kept on hold and, only if a few years down the line the first loan turns bad, the second loan gets disbursed to help the borrower service the first loan. Thus, a loan does not become bad at least for three to four years.

Creation of fee income: The art of “creating" handsome fee income was perfected by a large private bank in the second half of the 1990s and early this century; later, a few other banks opted for this and, currently, one of them thrives on this. Why do the banks do this? Market valuation. The community of analysts and investors loves fee income since it is considered a riskless steady stream and does not consume capital.

How does this work? Well, suppose company A is taking a Rs100 crore five-year loan at an interest rate of 13%. With the consent of the borrower, the interest rate will be brought down to 10%, and 3% will be converted into fee. However, this will be booked at one go and not amortized over a period of five years. That is Rs3 crore multiplied by five years, or Rs15 crore. For this, the bank’s sanction limit will be raised from Rs100 crore to Rs115 crore. The fees can be for processing and/or structuring the loan and, ironically, paid out of a bank’s loan itself.

By front-loading the fee income, the bank gets a lump sum at one go, which bolsters its profit. On the flip side, the bank will always be under pressure to book more and more fees every year to remain at the level achieved in the previous year.

Dilution of risk management: There has been at least one instance where a private bank diluted the importance of risk management. When it got a new chief risk officer (CRO) a couple of years ago, it changed the reporting structure. Instead of reporting to the CEO, the CRO was asked to report to the chief financial officer of the bank. By virtue of reporting to the CEO, the CRO would have been attending the board meetings by invitation; but now, that is blocked. In other words, in the new reporting structure, the board would not get a first-hand account of risks in the system. Incidentally, going by the Basel Committee on Banking Supervision Guidelines for Corporate Governance, the CRO should report and have direct access to the board or its risk committee without impediment.

Difference in scale: If a senior banker who started his career with a PSB and ended with a large private bank is to be believed, corruption exists in private banks, too, but there is a difference in scale. While some of the not-so-well-paid public sector bank chiefs may indulge in petty corruption, the well-looked-after private sector bosses with fat cheques and stock options go for big-bang gains. He was making a general statement and not referring to any particular bank.

Where is the second line? Another important aspect of most Indian private banks is the absence of a second line. When Vaghul was heading ICICI Ltd (1985-96), the erstwhile development financial institution that later became a bank, and even in the K.V. Kamath regime in ICICI Bank (1996-2009), there was a problem of plenty on the talent front. Now, most of the private banks do not have the bench strength to move into the corner room if the CEO steps down. With RBI raising the CEO’s retirement age to 70 in private banks, given a choice, probably most chiefs would like to continue till they attend the age and, hence, grooming a successor is not on everyone’s agenda.

Corporate governance: Finally, is corporate governance weak at private banks? There is no straight answer. Many banks follow the norms in letter, but not in spirit. There is no obvious violation of the rule; they are “compliant", but since the short-term focus is on results, mere compliance could erode the governance structure in the longer run. Unlike the boards of PSBs, which are in many cases ineffective and not capable of guiding the banks, the members of some of the private bank boards are “independent" in letter but “aligned" to the CEO in spirit. If one were to compare the stature of the directors on some of the bank boards now and a decade ago, the difference is quite stark.

Compliance is something which has to be done because of law or regulations. For instance, having a woman independent director on the board is a norm which a company needs to fulfil if its capital exceeds a certain threshold. By appointing a woman director, it becomes compliant; but an “aligned" woman director is not in sync with the principles of governance which goes beyond compliance. Most private sector banks are definitely compliant, but are they following the principles of governance?

By forcing the banks to disclose the divergence in quality of assets, RBI has taken the first step to address some of these issues. However, the investors in these banks with the maximum skin in the game have strangely been keeping quiet. In the case of a few banks, they have hardly got any return on their investments for years, but they do not show any sign of frustration against the management. In that sense, they are as benign as the government of India, the majority owner of the public sector banks which keeps on pumping capital in the banks but cares little about efficiency.

Tamal Bandyopadhyay, consulting editor at Mint, is adviser to Bandhan Bank. His latest book, From Lehman to Demonetization: A Decade of Disruptions, Reforms and Misadventures has recently been released

His Twitter handle is @tamalbandyo.

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