Tamal Bandyopadhyay: Of window-dressing and 'ever-greening'

In the first week of April, immediately after the end of fiscal 2003-04, some listed commercial banks started announcing their "business" growth.

Since Securities and Exchange Board of India (Sebi) regulations do not allow a listed entity to talk about its profit before the board considers its financial performance, banks choose to focus on their total business.

How do you measure a bank's total business? Nine out of 10 CEOs will tell you that total business is deposits plus advances "" although the bulk of the banking industry's income over the past few years has come from investment in government securities.

Why do banks focus only on deposits and advances to highlight business growth? The origin of this practice could be the Reserve Bank of India (RBI) norm of classifying branches on the basis of their deposits and advances.

Since every bank branch does not have a treasury wing, the regulator takes into consideration a branch's deposit and advance portfolio and adds the two to get the business profile. This is used to grade a branch and helps a bank keep a tab on branches that are critically important.

The business profile of a branch also helps a bank in its manpower planning. The manager of a Rs 500-crore branch (that is, deposit plus advances) is certainly a bigger banker than his counterpart at a Rs 50 crore branch.

The practice of computing the total business also reveals a psychological trait: even after accessing the capital market, most banks still focus on deposits and advances instead of more relevant financial parameters like profit, return on assets, returning on capital, earning per share and so on.

Most banks believe that continued growth in the deposit portfolio is confirmation of public confidence. Similarly, growth in advances is said to indicate corporate India's confidence in the bank. Finally, the total amount of advances and deposits also determines the bank's ranking.

The psyche of staying at the top in terms of topline (read "total business") "" and not bottomline (profit) "" is possibly the origin of an adroit but superficial and often misleading presentation of numbers. There is always a rush to increase deposits and advances by the end of the financial year. Once the mission is accomplished, the level of deposits and advances dip immediately.

For instance, in the last week of March 2003, banks' outstanding non-food credit was Rs 6,92,373 crore. In April 2003, the figure dropped to Rs 6,84,161 crore. The corresponding figures for March 2002 and April 2002 are Rs 5,49,986 crore and Rs 5,42,020 crore. The banks normally take a few months to get back to their year-end advance level.

In the 1970s and 1980s, when the financial system followed the January-to-December financial year, bank deposits used to swell on December 31 and vanish a day later. This was mostly done by using inter-bank money.

Though the deposit rates were fixed by the regulator in those days, interbank deposits were outside RBI's purview so banks could mutually decide the interest rate on these ultra-short-term deposits maturing in 48 hours.

Once the RBI took note of this practice, the duration of the deposits got longer "" from two days to two weeks or maybe a month but the practice continued even after the financial system shifted to the April-to-March financial year and the fortnightly system of maintaining mandatory cash balances with the central banks.

Banks have also become more ingenious about finding ways of window dressing. For instance, instead of depending on fellow banks, intermediaries started tying up with corporate clients. Under this arrangement, at the end of March, a corporation would draw its undrawn advances. The amount would then be simultaneously credited to its current account. This is essentially a book entry. Public sector undertakings also play a big role in "helping" banks in this way.

Small gifts "" ranging from cold coins to silver Ganesha statues "" often change hands in recognition of the help extended by a corporation to a branch manager's career graph.

This window-dressing sometimes leads to "ever-greening" "" a relatively new trend in the financial sector. Technically, ever-greening refers to the practice of "managing" the balance sheet through novel ways.

For instance, by inflating their advance portfolio through window-dressing, the banks can bring down their gross non-performing assets (NPAs) in percentage terms. This is simple arithmetic. A Rs 5-crore NPA on an advance base of Rs 100 crore translates into a 5 per cent NPA level. But when the advance portfolio goes up to Rs 120 crore at the end of the year, the NPA level automatically drops to 4.16 per cent "" even though no bad assets are recovered.

But the artificially propped up advance portfolio can have a negative impact too for those banks that are not savvy about priority sector financing. Commercial banks are required to extend 40 per cent of their advances to designated priority sectors like agriculture, small scale industries and so on (for foreign banks, export credit is part of the priority sector lending).

Now, when the advance portfolio swells, in percentage terms, the priority sector lending chunk drops the same way as the NPAs. But the banks have their own ways of tackling this. For instance, a bank that is missing the target can always buy out a piece of priority sector lending from a fellow bank which has "excess baggage" here at a price for a month or so. Later, the second bank can buy back the portfolio. In banking parlance, this arrangement is called inter-bank participation certificate (IBPC).

An artificial and temporary rise in advances is not the only avenue available to banks to bring down NPAs. The most popular alternative route is to grant an ad hoc facility to one of the stressed borrowers to help it meet certain contingencies. That is the official reason cited for granting the loan.

At the second stage, the same money comes back to the bank as interest payment. This is done when a company is not in a position to pay interest on its existing loan. (If a borrower fails to pay interest during a quarter (90 days), the facility becomes an NPA.)

In a variation of the same method, banks can give money to a subsidiary or a group company of the likely defaulter. This money is then lent by the subsidiary to the parent company as an inter-corporate deposit which in turn makes the interest payment and keep the account "normal" or standard in banking parlance. This method was adopted by a domestic consumer electronic company that recently floated a subsidiary overseas.

A bank can also lend money to a company to pay off another bank's loan. This way, the second bank can save an account from going bad and reduce its NPAs. The second bank can then extend a similar facility to a company that has not been able to repay loans from the first bank. This kind of incestuous relationship between banks was not uncommon even in the past.

A London High Court order last year directing Bank of India to pay $ 82 million in compensation for fraudulent transactions with the collapsed Bank of Credit and Commerce International (BCCI) illustrates this trend well.

The case focuses on six circular transactions between 1981 and 1985. BCCI placed short-term deposits with Bank of India and the Indian bank then lent the money back to a nominee of BCCI, allowing it to show a temporary improvement in its finances over its year-ends.

Judge Nicholas Patten in his order highlighted the culture of Indian banks in the 1980s when deposit mobilisation was the key to a successful career of a banker.

The most popular method of ever-greening is possibly restructuring of loans. How does this work? Normally, a term loan carries a period of moratorium and a borrower starts re-paying only after the moratorium is over. For instance, a seven-year loan can have a moratorium of three years. If the borrower is not in a position to stick to its payment schedule, a bank can always restructure the facility by extending the moratorium period. This, however, needs to be worked out well before the moratorium expires.

To be sure, there could be genuine cases for restructuring a loan but it is also true that some commercial banks have aggressively used this tool for their balance-sheet management.

All these take place under regulator's nose. They are not a violation of the letter of the law but certainly a dent on its spirit.