Reserve Bank of India (RBI) Governor Shaktikanta Das on Monday cautioned banks against aggressive growth strategies and the evergreening of loans, while also urging them not to allow any gaps in governance to creep in.
Addressing the board members of public and private sector banks, Das said it was found that some banks were resorting to “innovative” ways to conceal the status of their loans during supervisory processes, and “one method of evergreening was replaced by another” after being pointed out.
“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. He was discussing his 10-point charter, focusing on the soundness of the banking system and corporate governance, with the bank boards.
The evergreening of loans, in which banks artificially keep the loan classification standard, was one of the reasons for the sharp surge in non-performing assets (NPAs) in the previous decade.
In 2016, the regulator conducted a special review of banks’ books, known as asset quality review (AQR), and identified loans that need to be classified as non-performing. This led to a surge in bad loans.
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Citing NPA ratios – gross NPA at 4.41 per cent and net NPA at 1.16 per cent as of December 2022, the governor said while the banking sector was strong and stable with a capital adequacy ratio of 16.1 per cent, there should not be any room for complacency.
“It is in times such as these that complacency may set in. We have to bear in mind that risks often get overlooked or forgotten when things are going well,” he said.
The RBI governor delivered his speech on May 22 in New Delhi while addressing the board members of public sector banks, and on May 29 (Monday) to private bank boards in Mumbai. Observing that the business models of banks should be robust and prudent, Das emphasised on their asset-liability management.
“Over-aggressive growth, under-pricing or over-pricing of products both on the credit and deposit sides, and concentration or lack of adequate diversification in deposit/credit profile can expose banks to higher risks and vulnerabilities,” he said.
He said gaps were found despite the regulator having issued several guidelines to strengthen governance at banks. “It is a matter of concern that despite these guidelines on corporate governance, we have come across gaps in governance of certain banks, with the potential to cause some degree of volatility in the banking sector,” he said, adding while these gaps had been mitigated, it was necessary that boards and the managements “do not allow such gaps to creep in”.
He said banks’ compensation structure should reward prudent risk takers, and imprudent decisions should be discouraged.
“A compensation structure which does not distinguish between prudent risk taking and excessive risk taking often results in a culture of indifference towards risk taking. Banks need to rethink their internal accountability structures to ensure that prudent risk taking is rewarded and imprudent decisions are discouraged,” he said.
Reminding the boards that banks dealt with public money, Das said it was the responsibility of boards of directors and managements of banks to keep the interest of depositors uppermost in their mind.
He said board members must ask for all the requisite information from the management before making a business decision. “They [independent directors] have to always remember that their loyalty is to the bank and no one else. Directors should keep watch on actual or potential related party transactions,” he said.
The governor also said he had advised bank chief executives to speak to the media to dispel any misinformation spread in the social media.
“… in this digital age, it took only a few hours to transfer billions of dollars held as deposits in a bank to other institutions, leading to a severe liquidity crisis… We had to advise the CEOs to interact with the media immediately to set out the facts correctly. There have been instances when the Reserve Bank had to issue press statements to assuage concerns and prevent potential panic,” he said.