Fix governance to protect the small depositors

K Srinivasa Rao | Updated on October 21, 2019 Published on October 21, 2019

The impact of the sudden failure of PMC Bank is immense, exposing the vulnerability of small depositors   -  PTI

The impact of cases such as the PMC-HDIL fiasco on small depositors can impede greater financial activity. Corporate governance must be reformed to safeguard their interests

The collapse of Punjab and Maharashtra Co-operative Bank Ltd (PMC Bank) closely after other NBFC fiascos exacerbates the sufferings of many small and marginal depositors/borrowers. It clearly exposes the inadequacies in the supervision and regulation of corporate governance (CG) in formal financial intermediaries. Allowing the single borrower exposure of PMC Bank to defunct Housing Development and Infrastructure Ltd (HDIL) to reach a whopping ₹6,500 crore as against the total credit portfolio of ₹8,383 crore (until March 2019), four times the regulatory cap is a matter of dismay.

The admission and arrests of the bank’s Chariman, MD and CEO is a clear sign of lack of control that resulted in risking the entity. Other members of the board, the RBI and Registrar of Cooperative societies — the anchors of the value chain — could not sense early alerts to prevent concentration of risk. It is therefore necessary to introspect and find effective methods to insulate such weaknesses in governance to protect them in future.

Weak firewalls

The freeze on the functioning of PMC Bank, limiting withdrawal of deposits, appointment of administrator, suspending the board, calling for forensic audit of credit operations and events that followed the collapse are standard regulatory steps to protect the interest of stakeholders. But the collateral damage of such sudden failure of the financial entity is immense, exposing the vulnerability of hapless community of small depositors.

Despite such instances, customers usually repose high degree of confidence on banks and their regulatory system, despite deposit insurance restricted to mere ₹1 lakh by the Deposit Insurance and Credit Guarantee Corporation (DICGC). A deeper look into the reasons for failure of financial intermediaries exposes a glaring vacuum in implementing, enforcing and monitoring of principles of CG and its ethical dimensions.

Even the best, most diligent efforts of line management in such financial entities go haywire with the increasing nexus between few top management honchos and influential large borrowers. The firewalls of CG continue to be weak and enable few disgruntled elements to swindle the fortunes of millions of small and marginal depositors. The woes of such low-value bank users at the bottom of the pyramid slowly impede micro-economic activities, and can potentially trigger a protracted slowdown and prolong the revival of the economy. Hence, failures of even micro financial institutions need to be curbed by building appropriate safeguards and proactive systemic controls.

Regulatory reform

Serious introspection is needed to fix the missing links in monitoring CG. Regulatory reform in the financial sector has been a constant journey of transformation since the opening up of the economy, and is well calibrated to align with global standards. Various expert committees have attempted to bring robustness in CG standards; however, financial entities are still able to bring ignominy to the stability of the financial sector. Obviously, the risk is not necessarily confined to operations, but is strategic, calling for an overhaul of systemic controls.

The supervisory and regulatory systems have to be more focussed on capturing early signs of weaknesses in CG and functioning of subcommittees of the board. The institutionalisation of the chief compliance officer and chief risk officer could sensitise and bring a cultural shift towards risk and compliance, but more is needed to make them effective. Since they continue to form part of the internal top management team, they remain subordinate to the chief executive, limiting their role. An exchange of experts in compliance and risk between institutions as a full-time external resource reporting to the regulator may be needed rather than as a board nominee.

The continuous offsite monitoring through MIS and onsite, risk-based supervision should be able to bring about seminal improvements in due course, but more intense and pointed discussions on business models and how they actually pan out in managing balance sheet risk needs qualitative stress tests and proactive use of simulations to alert the bank.

The RBI has rightly taken steps to revamp its supervision and regulatory apparatus, and the ongoing fiasco can provide enough pointers. Better boardroom counselling on risk and surveillance through data analytics will be essential to protect the long-term interest of stakeholders of the financial system. Regulatory prescriptions may have to be supported with boardroom education on the nuances of managing sustainability and stability.

The writer is Director, National Institute of Banking Studies and Corporate Management. Views are personal

Published on October 21, 2019
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