Banks shouldn’t only be pleasing investors

RBI watching banks’ strategic decision-making closely will red-flag systemic risks

Banks shouldn’t only be pleasing investors
As Das said, banks must exhibit prudent risk-taking behaviour and use their capital efficiently.

RBI Governor Shaktikanta Das may have set the cat among the pigeons when he said on Tuesday the central bank is keeping a closer watch on the business models of banks, but he is absolutely right in calling the latter out. Indeed, Das did not mince his words when he said some lenders appear to be more interested in serving their investors, by following a ‘high-risk, high-return’ approach, rather than their depositors; he has advised them to not adopt a herd mentality.

The central bank’s objective is to be able to stay abreast of banks’ strategic decision-making on a real-time basis and identify any risks ahead of them becoming a threat to the financial system.

To be sure, the models haven’t really undergone any dramatic transformation over the last few years. However, the landscape is changing and technology is taking over. The entry of new players, fintechs in particular, warrants much greater vigilance over the financial system. Indeed, the regulator must quickly move to monitor the models of non-banks, especially those of lenders operating exclusively through online channels.

Importantly, Das has emphasised the role of bank boards in framing strategy, making a case for greater independence from non-executive members on the boards. Banks have indeed done poorly on that front. What was probably the worst instance of such dependence, and a shameful one at that, was when, in 2018, the chairman of a leading private bank called a press conference to defend the actions of the embattled CEO. Such cozying up needs to end; there needs to be a more professional relationship between the management and the board members.

While highlighting these weaknesses, it is hard to forget the presence of RBI nominee directors on the boards of banks—including state-owned ones—did little to preempt the post-2016 asset quality crisis. Perhaps the supervisory lapses of the past have prompted RBI to incorporate this new element into its supervisory architecture. Some of the flak that the central bank got was justifiable; it needed to have been much more vigilant and spotted the troubles brewing at Infrastructure Leasing & FInancial Services (IL&FS) Group and Yes Bank.

In both institutions, the business models were heavily reliant on evergreening of loans and related-party transactions. The regulator needed to have moved in and taken action long before IL&FS defaulted or Yes Bank’s capital adequacy reached precarious levels. Hopefully, we will see fewer crises and insolvencies now that RBI has decided to scrutinise business models and strategies closely, rather than just watching for regulatory compliance.

The central bank must also desist from pampering lenders. What helped banks carry on with evergreening—the practice of preventing loan defaults by extending more loans to the same borrower—were the various regulatory dispensations offered by RBI at different points in time. The alphabet/number soup of CDR, SDR, 5/25 and the like was used to prevent weak companies from turning defaulters until the asset quality review of 2015-16 finally forced banks to come clean about the degree of stress on their books.

Unfortunately, RBI was as complicit in the process of masking stress as the banks because of its unwillingness to roll back all the restructuring frameworks in time. The AQR should have happened five years before it did. Das cautioned on Tuesday the restructuring frameworks—to address stress arising out of Covid-19—come with their own risks. Lenders must deal with the stress, if any, by strengthening their models; they can’t expect RBI to ease the rules every time they are in trouble. That mindset must change. As Das said, banks must exhibit prudent risk-taking behaviour and use their capital efficiently.

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