RBI governor cautions banks against hiding stress, governance issues

The process of evergreening of loans is typically a temporary fix for a bank. If an account turns NPA, banks are required to make higher provisions which will impact their profitability. To avoid classifying a loan as non-performing asset (NPAs), banks adopt evergreening.

“Such practices (evergreening of loans) beg the question as to whose interest such smart methods serve. I have mentioned these instances to sensitise all of you to keep a watch on such practices,” Das said in his address at the Conference of Directors of Banks organised by the RBI for public sector banks on May 22 in New Delhi and private sector lenders on May 29 in Mumbai.

It is learnt that in the latest round of stress tests conducted for the banking system after the start of the global banking crises, banks had not fallen below the minimum regulatory requirement.

Stating that business models of banks should be robust and prudent, Das said bank boards need to pay specific attention to the asset liability management (ALM) in banks, as suboptimal ALM can lead to serious liquidity risks.

This is the second time in as many months that the Governor has spoken about the inappropriate business model adopted by some banks, which, if not corrected, can set off a bigger crisis.

In April, he said the RBI has started closely monitoring the business models of banks and financial institutions in the wake of the banking crisis in the United States and Europe.

In March this year, Finance Minister Nirmala Sitharaman also asked public sector banks to look at their business models closely to identify stress points, including concentration risks and adverse exposures. In the performance review meeting of the public sector lenders held in March, she urged the banks to frame detailed crisis management and communication strategies.

The Governor said the RBI has engaged with certain banks on the need to make suitable adjustments in their business strategies where it was observed that over-aggressive growth in certain business segments, be it in credit or deposits side, were creating avoidable vulnerabilities.

He further said the RBI has also noticed gaps in corporate governance of certain banks, which have the potential to cause some degree of volatility in the banking sector. “While these gaps have been mitigated, it is necessary that Boards and the managements do not allow such gaps to creep in,” Das said, adding that it is the joint responsibility of the Chairman of the Board and the Directors, both whole time as well as non-executive or part time Directors, to ensure robust governance.

Pointing towards the recent bank failures in the US, Das said public trust in the banking system is very crucial. “In this digital age, it took only a few hours to transfer billions of dollars held as deposits in a bank to other institutions, leading to a severe liquidity crisis,” Das said.

He also said it is important for banks to monitor information appearing in various media and clear the air on any rumours.

“We had to advise the CEOs to interact with the media immediately to set out the facts correctly. There have been instances when the Reserve Bank had to issue press statements to assuage concerns and prevent potential panic,” he said. He said individual directors on the board of banks should not have any conflict of interest which may hamper their objectivity and independence.

The Governor said there is a need for banks to rethink their internal accountability structures to ensure that prudent risk taking is rewarded and imprudent decisions are discouraged.

“Employees cannot be rewarded for increasing short-term profits without adequate recognition of the risks and long-term consequences,” he said.

Das’s remarks come when the Finance Ministry has made repeated references to the improvement in the financial system as a potential enabler for catalysing growth.

On March 16, Chief Economic Adviser V Anantha Nageswaran had called for building “margins of safety” amid global uncertainty, adding that real interest rates in India are not yet restraining enough to offset the buoyant demand for credit and double-digit credit growth because, according to him, it merely reflected improved balance sheet strength and the improved appetite for borrowing across sectors.