The way banks have been providing for liabilities disproportionately in different quarters over the years came to the attention of all stakeholders and regulators when the fourth quarter results of State Bank of India (SBI) for 2010-11 devastated investor confidence and credibility in financial reporting. This impacted the bank major’s share price plummeting to one of its lowest marks.
A change in the chairmanship of the country’s largest bank after five years enabled the bank to make unprecedented additional provisioning in the last quarter of the year to cover up inadequate provisioning for non-performing assets (NPAs) and pension liability for the preceding three quarters as required by the Reserve Bank of India’s (RBI) prudential norms and applicable accounting standards. This caused the bank’s profit to decline 99 per cent to Rs 20.88 crore in the January-March quarter from Rs 1,867 crore.
The RBI’s financial prudence norms stipulated that all banks should provision for 70 per cent of their NPAs and had set a September 2010 deadline. But where most banks made incremental provisions in each quarter to reach the prescribed level, SBI opted not to follow them till March 2010. So SBI’s NPA coverage was just 44.36 per cent compared to Bank of Baroda’s 74.46 per cent. ICICI Bank, ranked second in India by assets, reported 59.48 per cent coverage and Punjab National Bank 69.46 per cent.
Had the management provided for the additional NPA coverage from the time of the RBI stipulation, the impact per quarter would have been Rs 570 crore instead of the large Rs 2,330 crore made in the January-March quarter. SBI, being the leader in the banking industry, should have set an example by taking the lead to achieve the required coverage instead of waiting till the last quarter.
Again, according to the RBI’s directive in November 2010, all banks offering teaser home loans had to provide higher provisioning of two per cent instead of 0.2 per cent earlier — which worked out to Rs 500 crore for SBI. Though its auditors asked it to make the higher provision for the quarter to December 2010, SBI made the provision only in the fourth quarter.
Though the need for provisions arose on account of wage revision in 2010, conservative accounting norms insist that provisions for such liabilities should be made from the year they become due based on broad estimates. SBI finally made a large provision of Rs 7,927 crore in the 2010-11 fourth quarter. Having insufficient profit, it had to draw this amount from the reserves, depleting its Tier-I capital below the benchmark eight per cent to 7.77 per cent. Since the government holds 59.40 per cent of SBI’s equity, it was not convinced enough to permit the bank to go ahead with rights issue that had the potential to raise up to Rs 20,000 crore.
The fact that there are wide fluctuations in SBI’s profitability whenever the leadership changes is a sad reflection on the quality of governance in the bank, despite the RBI’s stringent norms and the entire gamut of corporate governance systems in place. The overwhelming power and influence of the chairman in deciding when and how mandatory provisioning should be carried out seems to prove that the pillars of the corporate governance architecture – board of directors, audit committee, the internal control framework, internal and external auditors – abdicate their collective wisdom and fall in line helplessly with the dominant leadership. The issue deserves to be examined in depth in other banks too.
The judicious application of prudential norms and accounting standards over the years could have averted erratically fluctuating stock prices owing to inappropriate reporting of quarterly financial results. If corporate governance in its true spirit is to be put in place, there seems to be a need to scrutinise the method of selecting members of the audit committee and reviewing its functioning. Fresh guidelines for fine-tuning quality governance may also be needed to deter inappropriate application of prudential norms. There is a case for overseeing the recent change in methodology of appointing auditors, who are selected by the management among the empanelled audit firms that compete fiercely for a few highly remunerative bank audits, instead of by the RBI and how auditors conduct the audit and differ in interpreting and applying the same norms.
All this may require a comprehensive review of provisioning and application of prudential norms cutting across all public, private and foreign banks. There is also a need for the Institute of Chartered Accountants of India to streamline its overseeing function and issue further guidelines to make auditors follow a code of ethics, irrespective of compulsions, even in circumstances in which powerful managements try to distort professional judgement in their favour.
The author is Director General in the Comptroller and Auditor General’s office. These views are personal
