Tamal Bandyopadhyay: Private banking: the long arm of the promoter

The Reserve Bank of India's (RBI's) draft guidelines on ownership and corporate governance in private banks have outlined the regulator's vision of the private banking universe.

Thus, no promoter can hold more than a 10 per cent stake in a bank and no private and foreign bank can hold more than 5 per cent.

The widely diversified holding pattern is expected to ensure corporate governance, while the proposal to raise the net worth of all private banks to Rs 300 crore is designed to lend stability to the system. Will the guidelines achieve all this?

The world of private sector banks is quite unique. Irrespective of their actual holdings, the promoters run the show and influence every decision "" from investing a few hundred crores of rupees to recruiting a watchman.

Take the case of an old private sector bank that was set up before Independence. Five years ago, the bank was in the red with accumulated losses of over Rs 150 crore and a capital adequacy ratio going below 1 per cent against the RBI- stipulated 9 per cent. Since then, it has clawed back into the black with a double-digit net profit last year.

The bank's performance has improved on every front. Gross non-performing assets (NPA) were close to 30 per cent (that was the official figure; the actual figure could be around 50 per cent) a few years ago. Today, that figure is substantially lower and the net NPA is less than 3 per cent.

With over 4,000 employees and close to 400 outlets, the bank is now in the pink of health. By the traditional yardstick of assessing a bank's business profile (that is, deposit plus advances), this is a Rs 10,000-crore bank.

Credit for this turnaround largely goes to the promoter who officially holds a stake of less than 50 per cent. By virtue of being the promoter, he also happens to be the chairman of the bank.

While scripting this turnaround story, the promoter indulged in other things that he is not expected to do. For instance, till recently, he rented his own flat in Mumbai to a senior executive of the bank for a sum that was way above market rates. The bank executive had to look for another house after the RBI directed the promoter to stop.

But the regulator could not stop him from selling his group company's property to the bank at about Rs 6 crore, which is possibly higher than the market price. The bank has bought this property (which does not have a clear title, nor is the deal registered) in Mumbai to open its branch.

What is more, both the bank's zonal office as well as the corporate office are located in the premises of the promoter's other companies. The promoter's relatives also own the two guest-houses that the bank rents in Mumbai.

The root of the problem is that the promoter, who owns a group of companies, wants to run the bank like a manufacturing outfit. This is not an ideal situation since, unlike a manufacturing company, the bank has millions of depositors and it needs to keep their interests in mind.

While the promoter has pumped in a several hundred crores as capital, the depositors' money runs into thousands of crores.

To get a better grip of the bank, the promoter recently established the bank's corporate office in Mumbai, although its headquarters continue to be located elsewhere.

With the shift, every important department of the bank "" credit, investment, treasury, recovery, the board secretariat, office of the managing director as well as deputy managing director and executive director "" are now almost located in the backyard of the administrative offices of the promoter's other businesses.

This has been done to enable the promoter-cum-chairman to keep a tab on every single corporate decision that is taken in the bank. Walk into the bank's corporate office and you will find him sitting in his cabin and holding meetings with the senior management every day. This is certainly not a non-executive chairman's job.

Technically, the managing director of the bank can sanction loans up to Rs 3 crore but in reality he cannot sanction a single proposal without the chairman's nod. Even a loan proposal worth Rs 10,000 cannot be sanctioned without the chairman's (read promoter) clearance.

Does that mean the promoter-cum-chairman is blatantly violating all norms and extending loans to its own companies? To be fair, he has not violated any lending rules and the bank does not have any exposure to the promoter's group companies.

He has, however, been leveraging the bank in a different way. Take a look at the list of bankers of his group companies. You will find many old and new (that is, post-liberalisation) private banks as well as public sector banks on that list. These banks extend loans to his companies.

In turn, his bank parks deposits with some of them at rates that are well below market rates and also subscribes to their Tier II capital when they come to the market to raise subordinate debt.

He also takes other small advantages. Take a look at his bank's balance sheet. The legal expenses are quite high. Ditto for expenses on communication (public relations). It is possible that his companies' legal and public relations expenses are loaded here.

Recently, his bank opened extension counters at his factories located in a Union Territory to cater to the banking needs of mill workers. The bank is also buying apartments in these areas for their employees who will run these extension counters. No one is sure about the commercial viability of these outlets.

The promoter also has the last word on every promotion, transfer and recruitment. It's no surprise that some of the employees who have been recruited recently are relatives of executives in central bank, the income tax department and the registrar of companies "" in other words, with those with whom the promoter wants to maintain relationships to keep his other outfits going.

One can argue that the promoter cannot run a bank at his whims because, after all, it is board-driven. This argument is theoretically acceptable since the board consists of independent directors.

But who are these independent directors representing various interest groups like small-scale sector, agriculture and so on in his bank? They are the promoter's father-in-law, cousin and family friends.

There are two nominee directors from the RBI. Both are retired central bankers and possibly do not bother much about things happening around them.

Since the bank does not have a managing director now, a committee of directors (consisting of the chairman and some board members) meets every week to oversee loan sanctions and other operational aspects. Since a director gets Rs 5,000 per sitting, the outgo for the bank works out to about Rs 20,000 a month.

This can be taken as a typical case study of a promoter's role in a private sector bank. While he is not strictly violating rules and mortgaging the bank to the stock markets, he is running the bank like a personal fiefdom and taking full advantage of petty benefits.

This kills the soul of corporate governance. By centralising all decision-making powers, the promoter is also killing professionalism in the bank.

This particular promoter's term as a chairman will end soon. The RBI may extend his term. Even if it doesn't, it is reckoned that he will continue to run the bank, since the central bank is unlikely to quibble with micro management if the bank is doing well.

Thus, it does not really matter whether the promoter holds a 10 per cent stake or more or whether he is the non-executive chairman or an ordinary director. Most of the promoters in the private sector have a long arm and they normally find it difficult to stay away from their banks.