Sunday, February 25, 2018
Commercial banking is the most important financial intermediary in developing economy. Countries like India require robust and sound banking system to support sustainable economic growth. A fragile banking system would inflict heavy cost to our future economic growth. Unfortunately , currently Indian Banking system is passing through its worst phases since independence. Considering the importance of banking in the economy , an impartial analysis of the root cause of some of these challenges must be carried immediately to prevent catastrophe in the future . In this article , I shall articulate my views about challenges of the banking systems and I shall also mention three areas where risks would emerge sooner than later in the banking system.
Root cause of the problem :
Indian banking system survived the Global Financial Crisis ( GFC) of 2008 without much of problems . Without taking away the credit of the robustness of Indian banking sector , I want to highlight the most important fundamental reason which helped Indian banking system to overcome GFC without much problems. Bank would never fail if large number of depositors do not withdraw deposit within short period of time. In India , depositors feel that banks are government owned and accordingly government would not allow banks to fail. This perception arising out of government ownership of banks play the most important role about stability of the banking system in India . banks and regulators have very important roles to ensure maintenance of public trust on banks. However , banks and regulator have given credit for stability of Indian banking system due to strong risk management practices being followed by Indian banking system . Banks and regulator have credited themselves by accepting the fact that their strong risk management system is the main reason for such unflinching faith of public towards the banking system. However , the reality may be that common public never understood and may not also understand in future about so called “ risk management ” of the banking system. The reality is the government ownership of Indian baking system for such staunch public faith in Indian banking system. This wrong perception of banks and regulator led to the phenomena of going into a mode called “self denial” mode. Indian banks , regulators as well as government are in this “ self denial ” mode about Indian banking system. I strongly feel that this self denial is the root cause of the paramount problem Indian banking sector facing today. If Indian banking system has to come out from this mess , the starting point should be to awaken up to reality and come out of this “ self denial ” mode. If we do not address this root cause , it is not possible ( believe me absolutely not possible ) to come out of the mess of the Indian banking system. The recent surge of NPA and the latest instance of fraud case of Punjab National Bank ( PNB) blatantly tears apart our claim of presence of strong risk management system in Indian banking . It is impossible to believe that the recent fraud case of PNB is an isolated case ( as pointed by one of the top banking bureaucrats of India ). There are many such cases inside the Indian banking system. The self denial mode simply rules out any further step to identify similar types of potential fraud cases as we are not accepting that this is a systematic problem. One media entity called Cobra Post highlighted the blatant deficiencies of KYC compliance in the Indian Banking system. However the immediate reaction of regulator was denial of existence of systemic problems. However subsequently it was observed that findings of cobra post are not isolated cases ( if this is the case , why regulator would impose penalties to banks ? ). Once we accept that our risk management systems need to be improved significantly regulator and other stake holder must roll out time bound programme to improve risk management functions of banks.
Building up a proper risk management system for banks : Updation of skillsets of regulators :
Banks have to realise that risk management is not only a compliance function . It has to be internalised inside the bank’s DNA. This can only be done by ensuring very strict compliance and also by imposing heavy penalties for non compliance. Here regulator has to play an important role. The job should start from doors of regulator. If we analyse impartially , regulator can not absolve themselves from taking some blames of this mess . The growth of this colossal mess has happened over the years right under the nose of regulator . This clearly indicates that supervisory functions of regulator need significant improvement. Proper skillset updation is must for regulatory officials. Regulator must design a comprehensive programme for time bound updation of skillsets of its officials . Government should work with regulator so that such programmes should put in place immediately without any delay. Modern techniques of artificial intelligence and big data analytics can be used to build such skillsets within shortest possible time.
Focus on strict compliance : The time has come that regulator should deal with non compliance issues with strict hands. Regulator should impose heavy penalty ( in the line with regulator of western countries specially USA) without any further delay. Under today’s scenario, banks have an incentive to pursue non compliance as the benefit out of non compliance is substantially higher compared to penalties paid to such non compliance. Once banks pursue process and methods associated with non compliance , it is very difficult to shift from such path . In recent past , we have numerous non- compliances cases ( foreign exchange violations in Delhi , violations of KYC during demonetisation , inconsistencies regarding annual results and violations related to information asymmetries around financial results ) where both Public Sector Banks ( PSB) and Private Banks ( PB) are involved. However regulator has not penalised involving banks in an exemplary manner so that they should not repeat such things in the future. This type of lenient approach of regulator would only encourage banks to continue with the practices of violating norms. If regulator does not start this process from now , it would be too late and the cost would be exorbitantly high.
Corporate governance of Board of Directors of banks : Board of Directors of banks has to take accountability related to lapses of banks. Regulations should be strict so that Board of Directors is performing its fiduciary duties in true senses. Numerous depositors of banks have reposed their trust on Board of Directors of banks and Board of Directors of banks should not let them down. We are observing very disturbing situation where the authenticity of financial numbers passed by Board of Directors are questioned for Indian banks. Time is running out for Board of Directors of Indian bank . If Board of Directors does not take ownership , people would not believe numbers and statement of banks and this can led to collapse of trust and faith of the banking system built over so many years. Regulations as well as self imposed guidelines should work in tandem to address this situation where uncomfortable questions are asked about efficacy of Board of Directors of many banks.
Activities that would create problems for banks :
Money laundering : Money laundering has the maximum potential to wreck havoc to the Indian banking system. Currently this menace is spreading its tentacles in the Indian banking system at an enormous pace. Banks are ill equipped to handle such menace at the current situation. Regulator should form special task force and roll out time bound action plan to address this menace immediately unless it is too late.
Operational Risk : Even though money laundering is subset of operational risk , other areas of operational risk is likely to create tremendous problems for banks in the near future . Appreciation of operational risk in the banking system is very poor at present and serious steps are missing to sensitise organisation about operational risk . Regulator and government must roll out time bound action plan to address this deficiency.
Non Performing Asset: Non Performing Asset would likely to pile up in the system in the near future with tremendous amount of stress being build up in the Non Banking Finance Company (NBFC) and Micro Finance Institution (MFI) segments . The credit underwriting framework must undergo complete overall due to change in business environment and change overall business dynamics. Regulator should initiate process to overhaul this credit underwriting methodology immediately so that banks change their credit underwriting framework at the earliest .
Indian banking system is at cross roads today . It needs urgent and decisive actions. Some of this action may be very drastic and very unpopular . Cancerous part of the system has to be removed ruthlessly irrespective of the pain involved. Failure to do so implies cancerous becomes fatal . Stake holder of the Indian banking system has to select the path immediately. Any delay would lead to catastrophe the cost of which can be enormous for India.