The Reserve Bank of India has come across instances of banks adopting so called smart accounting methods to artificially boost their financial performance, including bringing two lenders together to evergreen each other’s loans by sale and buyback of loans or debt instruments, according to Governor Shaktikanta Das.
The Governor flagged instances of good borrowers being persuaded to enter into structured deals with a stressed borrower to conceal the stress; use of internal or office accounts to adjust a borrower’s repayment obligations; renewal of loans or disbursement of new/ additional loans to the stressed borrower or related entities closer to the repayment date of the earlier loans; among other methods.
“We have also come across a few examples where one method of evergreening, after being pointed out by the regulator, is replaced by another method.
“Such practices 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 at the Conference of Directors of Banks organised by RBI.
The Governor emphasised that the Board of Directors, especially the Audit Committee of the Board (ACB), should pay close attention to accounting policies followed by the banks, and implement preventive controls to preclude smart or aggressive accounting practices.
The Board or the ACB should engage with the Statutory Central Auditors of the bank to ensure that their financial reporting is transparent and prudent.
The Governor noted that from time to time, the Reserve Bank 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/ deposits) was creating avoidable vulnerabilities.
“Problems or risks can come from one corner of the balance sheet, which might appear insignificant in the beginning. Let me emphatically state that the Reserve Bank does not interfere in banks’ commercial decision-making, but only gives them a nudge to address potential risks and vulnerabilities.
“It is expected of banks that they put in place robust risk management policies and practices to address the risks associated with their business model/ strategy,” he said.
Look beyond power point presentations
Das observed that RBI’s supervisory assessments have revealed that, sometimes, the information being put up to the board is laden with gaps and material inaccuracies.
Further, the agenda notes that the boards were reviewing did not capture all the relevant information, which made their review either ineffective or partially effective.
“We have come across instances of agenda papers not being circulated well in advance. There have also been instances of power point presentations being circulated as agenda notes. These power point presentations are like a guided tour, and directors should clearly look beyond a guided tour,” Das said.
He underscored that it is the responsibility of the senior management to provide material information to the board in a timely, accurate and understandable manner so that it can take informed decisions.
Despite guidelines on corporate governance, RBI has come across gaps in the governance of certain banks, with the potential to cause a degree of volatility in the banking sector.
“While these gaps have been mitigated, it is necessary that boards and managements do not allow such gaps to creep in,” he said.
Directors: Truly independent
Das emphasised that individual directors should not have any conflict of interest which may hamper their objectivity and independence.
“It is the responsibility of the board to ensure that policies to identify potential conflicts of interest are in place.
“In this respect, it is necessary that ‘independent’ directors are truly independent; that is, independent not only of the management, but also of controlling shareholders,” he said.
Independent directors have to remember that their loyalty is to the bank and no one else.
“Directors should keep watch on actual or potential related party transactions. They are expected to ask pertinent questions and obtain the required information from the management before taking decisions.
“I am not advocating any confrontation, but only stressing the need for the required level of alertness among all directors,” he said.
Referring to cases where RBI has noticed the dominance of CEOs in board discussions and decision-making, Das said: “It has been seen in such cases that boards do not assert themselves.
“We would not like such a situation to develop. At the same time, there should not be a situation where the CEO is inhibited from doing his duties. Directors and CEOs should, therefore, foster an atmosphere of free and fair discussion in board meetings.”
"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 were creating avoidable vulnerabilities," Das said.