Rebuilding Trust and Ethics
Rebuilding Trust in FIs is the need of the hour
Serious Irregularities persists across Financial Institutions (FIs): Reserve Bank of India (RBI), in the last two months, indicated in no uncertain terms, that when persistent non-compliance/serious material concerns are noticed, it will go to any extent, even if it means stopping a business in full/part so as to protect the interests of customers. . While the fines and penalties imposed on some entities in FI sector can be termed as ‘operational and procedural non compliance issues’, the same cannot be said in respect of at least, the following three FIs.
1. A Payment Bank was directed to not to accept new deposits/credits into deposit accounts/PPIs/Wallets, etc. as it repeatedly non-complied with the regulations in force and there existed confirmed material supervisory concerns.
2. A NBFC, having one third of its credit portfolio under gold loans. was found to have (i) seriously deviated in assaying and certifying purity and net weight of gold at the time of auction (ii) breached loan to value ratio in many loans sanctioned (iii) cash mode was adopted way beyond the ceiling, while sanctioning/effecting recoveries and (iv) not complied with standard auction processes. The NBFC is prevented from sanctioning of/ disbursing new gold loans, till RBI is satisfied that the supervisory process is resilient to the satisfaction of the regulator.
3. Another NBFC is advised to not to finance against shares and debentures as serious irregularities were found, the major ones being (i) a set group of customers were operating with meagre margins on such loans (ii) the company was operating the demat accounts of customers, using the PoA executed in its favour, amounting to the NBFC acting both as lender and borrower to the same customer. A special audit is to be instituted and lifting of restrictions will be only after the audit is complete and the NBFC addresses all the concerns of the audit report. SEBI followed suit by barring another financial firm in the same group to manage new debt issues.
Implications:
1. The irregularities pointed out have the ability to shake the ‘trust’ of the stakeholders of the said FIs and also cast a shadow on the corporate governances practiced by the boards of the FIs concerned.
2. The risk management committee in the said institutions were not independent, but appear to have functioned more as an arm of the business verticals to achieve the FI’s revenues and targets.
3. Though the risks might not turn into a 'systemic one’, the serious irregular practices mentioned by the regulator have occurred in FIs, which carry significant business levels and happen to be actively listed entities. The volatility of the shares of the firm/parent/group firm in the stock market, after RBI notified the actions taken against these FIs, confirms that. There is no guarantee that the incidents in the said FIs are in isolation. It may even be a tip of an iceberg, no one is sure.
4. While apparently no written instructions for violation of norms were issued by the FIs concerned, the irregularities pointed out adds credence to the general apprehension that unethical practices, when resorted to, normally spread very fast by word of mouth across staff and branches.
Need of the hour:
A. Avoiding 'holier than thou' statements: The payment bank, which was asked to stop accepting deposits/ credits by RBI, reconstituted its board, bringing in veteran bankers and retired IAS officers as independent directors. It is a good move to communicate that the compliance is given the needed importance. However, it could have avoided statements from the new directors with their mission statements. This is not normally done as the directors report to the board only. Similarly the NBFC, faced with the issue of deficiency in assaying and certifying purity of gold, is reported to have plans to replace internal assayers with certified external experts and this comes as a news item in the business dailies. The steps announced/planned in both the cases are healthy steps of course, but are not adequate to restore the trust/confidence of all the stake holders of the FIs concerned. (I consciously used the term stake holder and not share holder). When under a cloud, the best way for a FI to win back confidence of the investors/public is to work silently in the background for the time being and demonstrate its 'intent to correct' by way of results in due course.
B. Corporate Governance in boards needs demonstration: Whenever one come across failure of corporates, not for business reasons, it is usually observed that the board of the corporate was filled with independent directors of eminence, known for their impeccable integrity, etc. It was the trend in the past, is the trend now and might be so in the future also. Heated questions are debated about the absence of corporate governance practices, when such persons of repute adorned the board. The answer is simple. The independent directors were not part of the frauds/misdeeds definitely, but they have also not played their role effectively as independent directors of the board. Selecting the directors based on qualifications and other terms and conditions stipulated by RBI alone might not ensure best corporate governance practices, unless the selected directors bring upon their rich experience in a bold way to discharge their duties as independent directors. No immediate solution is seen, as selection is based on the individual's past track record and it is cast on the individual to play the role expected of him. Sadly, no appraisals are made on the performance of directors as is done for management staff, officers, employees, etc.
C. Prevent profile data abuse/misuse: So far, everyone was concentrating on privacy of data to ensure that no hacking take place. Now there are instances to link a single PAN with thousands of customers, link mobile numbers available in customer profiles with innumerable fictitious names, etc. within the FI itself. Data privacy being violated for inflating customer base is a new trend. The regulator needs to review its policy of protecting the customer data within the institution/group urgently.
D. Significant Gold Loan portfolio across all FIs calls for more safeguards: Gold loan is no longer confined to gold loan companies. It is spread across MFIs, NBFCs, SFBs, RRBs and all other SCBs. FIs increasingly turn towards gold loans due to attractive pricing, loan sanction is based on value of security and not on repaying capacity, recovery lies by way of auction than court intervention, achievement of agriculture under priority sector for banks etc. Purity of gold and net weight after deducting stones, etc., play a major role in disbursal and recovery. RBI may do well to form a committee to review the different practices adopted and if possible adopt a common system and procedure in respect of gold loans.
E. Group carrying diversified financial services shall be engaged in a better way: Related party transactions, maintaining 'at arms length', intra-group transactions are normally the watchwords, while carrying out inspection of a FI or its group of firms. But SEBI has barred a financial services firm now from managing new debt issues, as prima facie 'group involvement' was found in a group having firms engaged in merchant banking, brokerage and financial services. This is something new. Both the regulators SEBI and RBI need to review the guidelines in respect of a group of firms engaged in different financial activities, but have common customers to deliver the different financial services for a single project/issue.
F. Appropriate disclosure to be brought in, in the annual audited financial statements on regulator's critical observations in its audit: RBI may bring out changes in the disclosure statements to be made along with annual statements by FIs to indicate the kind of non compliances pointed out by the regulator and the progress made, similar to divergence in NPAs/provisions now published when divegences exceed a ceiling/limit
G. Credit Rating Agencies must be mandated to indicate that the deficiencies pointed out by the regulator had been factored before arriving at the credit rating for an issue/ of the company.
Finally, as the regulator's actions on the FIs are perceivably on the increase than that is observed in the normal circumstances, there is an urgent need for the regulator/FIs themselves to initiate proactive actions to assure the stakeholders and the market that the business is carried on transparently and through fair means.
Regards
V. Viswanathan
10th March 2024
If the fence starts eating the crop, what can be done? In the name of business, many institutions are throwing caution to the winds
ReplyDeleteYou are right
DeleteWhat is the accountability of independent directors, RBI directors, govt directors? No one seems accountable. That is the problem
ReplyDeleteYes. Accountability stops with management
DeleteFrom Harishankar Retd MD & CEO
ReplyDeleteThis article is very timely.
Dry docking is an important schedule in maintenance of sea-going vessels. It gives an opportunity to look at the submerged portion of the vessel and see what's wrong and where so that preventive care can be given or appopriate repairs can be done. Financial institutions also have to be dry-docked to see where they have started rusting... We don't do this. Nor do the Boards of these institutions. They are not mandated to do such an exercise. We end up having crises.. and doing firefighting. How an Institution can be dry-docked? We can't stop the business. The institution has to be a going-concern. Then how?
1. First of all Identify the submerged areas - meaning what processes we believe as the ones that make the business run :- the operative guidelines, CBS (believing that almost all FIs are on CBS) are the below-the-waterline mark.
2. Identify those out of the above, which are large in terms of volume, capital commitment and earnings.
3. Identify out of 2 above, those which have more external dependencies from an IT perspective (rendering a potential Cyber Security Threat)
4. Also Identify out of 2 above, those which have intrinsic sensitivities like - margin (LTV), interest rate movement, floating and frequently prone-to-change market rate for the underlying asset (as in the case of value of Gold in Gold loans)
5. Identify instances of deviation - on 2 and 4 above as also the degree of deviation and value of the deviations, Expected Loss and additional Capital Charge
The RMD of the Bank and RMCB of the Board should be the role holders.
The actual dry-docking happens when the IRMD does the test checks on the five areas above, collate findings and ascribe EL values and Capital charge on the same.
This has to be ingrained in the RM Policy of the Bank and quarterly discussions to the Board should be there in the Calendar of Board agenda.
Regulatory reporting of the deviations (quarterly) should be there as an action binding on the board.
In my view this this the Dry-docking that FIs can practise.