Merging commercial and treasury ops in banks would give them greater flexibility

By Sunil Kanoria 

In the Indian banking system, at present there exists a clear demarcation of roles when it comes to lending and investment operations. The ‘commercial’ division carries out the lending operations, while the ‘treasury’ division conducts the investment operations. However, the treasury division mostly invests in government bonds, and not corporate bonds. Therefore, given the low yields of government bonds, banks essentially have to depend on the interest earnings from the loans given out for a healthy bottom-line growth. However, Indian banks today are among the least profitable in the world. The bad loans problem in our banking system, especially in the public sector banks, has severely dented profitability through greater recognition of bad assets and rising write-offs.

Although gross non-performing assets (NPAs) as a percentage of gross advances are expected to marginally improve to 10.3% in March 2019 (from 10.8% in September 2018), Indian banks’ return on assets (RoA), the common measure for bank profitability, stood at (-0.1%) in 2018.

The recapitalisation programme undertaken by the government, the Insolvency and Bankruptcy Code (IBC), and the deferment of the adoption of Ind AS accounting standards are providing banks some relief. Lending activity has started picking up, but banks are much more cautious now. What is needed for the banking sector at this stage is structural reforms—be these on empowerment of bank boards, risk mitigation practices, talent recruitment, retention and compensation, manpower training, induction of technology, or even ownership structure. Many of these have already been highlighted in the PJ Nayak committee recommendations. Perhaps it is the right time to revisit the committee’s findings.

Talking about structural reforms brings me back to the point where I started from—the parallel existence of commercial and treasury divisions within the banking set-up. This is something worth a relook. After all, the end-objective of both giving out a loan and making an investment is the returns that accrue to the bank. Then why have two separate divisions? Just imagine what can happen if the lending and investing activities are brought at par.

There will be no need for two separate divisions. The two would become one and that would allow banks greater flexibility in terms of their financing decisions. In fact, this is now the global practice.

With our banking sector getting ready to embrace Ind AS norms, it is high time for our banks to embrace this practice of merging the commercial and treasury divisions. Imagine a scenario where a project SPV approaches a bank for funds. It is now up to the bank to decide whether to provide a loan to the SPV, or to purchase bonds of that SPV. The bank, while taking the decision, would need to factor in a future possibility of the project running into some trouble or getting halted. In such a scenario, if the bank has given a loan, recovering that loan can become a headache. But if the bank has purchased bonds from that SPV, all it needs to do is just sell off the bonds in the market. With this, the decision making at banks can get much more professionalised. A move like this will go a long way in infusing life into the corporate bond market as well.

In fact, a recent diktat by SEBI mandates listed companies with AA rating and above and with outstanding loan of a minimum of `100 crore to tap the bond market for 25% of their incremental long-term funding needs. While this diktat may have been a cause of anxiety for some, the move to merge the commercial and treasury divisions in banks can address, to a large extent, these concerns.

In fact, SEBI should consider allowing companies with ratings less than AA to be included in this as well. Companies with AA rating and above would any way be able to raise funds from the market. Only by including companies with ratings less than AA can the bond market be expanded.