Banking headlines over the last few months have been dominated by a decline in specific bank share prices that have highlighted both the broader credit issues in the economy and the lack of speed in recognition of Non-Performing Assets (NPAs). However, the problems around the Punjab & Maharashtra Co-operative Bank Limited (PMC) came as a stark reminder that the banking system clean up in India still has significant work to be done not just in terms of credit quality selection but also structural corporate governance issues that form the fundamental pillar of the economic growth agenda.
The four primary issues that the recent news around Indian banks bring to the fore are i) Poor decision making due to a lack of capacity to judge project quality ii) A structural asset-liability mismatch for the banks due to longer-dated assets and short-dated liabilities iii) A delay in recognising NPAs on the books iv) Outright fraud and absence of fundamental corporate governance standards. While the first two factors have received significant coverage, the last two factors probably deserve even greater attention going forward given the grave issues that have once again reared their ugly head over the previous few months.
An alternative way to view the issues above is as the building blocks on which any credit framework is built. Solutions that address the fourth point mentioned are the basic premise of a robust and functional credit mechanism. Solutions for the third point build on those for the fourth, and so on. Essentially, the banking system solutions need to build on one over the other. Otherwise, solutions that provide higher capacity for lending institutions to judge project quality will be rendered useless without basic corporate governance standards.
It is also vital to once again emphasise that the solutions for all four problems mentioned above are distinct. While the first two revolve primarily around the skill and capacity of the lender to assess sectoral, company and project risk keeping in mind the micro-structure of their balance sheets, the last two are to a large extent related to the level of corporate governance. The solutions needed to tide over the four main banking issues are therefore distinct, and yet equally necessary to resolve the problems at hand.
Going forward, both the central bank and the banking regulators must further emphasise solutions that allow for better, more precise and more consistent classification of NPAs on banking books, while at the same time ensuring that the information flows through the system. At its very core, the issues revolving around information asymmetry need to be urgently addressed. Timely recognition of NPAs is essential not just for the asset quality reviewal of the bank in question, but also to ensure that the NPA classification information regarding the credit instrument or company in question is passed onto the market for better decision making.
Additionally, the issues at PMC bank seem to suggest that the problems are linked to the fourth factor mentioned above of outright fraud and the absence of basic corporate governance standards are still prevalent and need to be urgently addressed. News that suggests that single borrower exposure for PMC bank was way higher than any reasonable limit from a credit analysis perspective and that the same was achieved through devious means points us towards the need for regulations that allow for greater clarity and the prevention of outright fraud. Most importantly, the delay in recognition of the fraud suggests that the rules around accounting issues for banks need urgent redressal.
Over the last few years, significant steps have been taken to clean up the Indian banking system. However, issues such as the PMC bank suggest a lot more needs to be done. The facts regarding PMC bank also indicated that such problems are ones we have seen earlier, thereby further emphasising on the importance of expediting the clean up of the banking system and implementation of new regulations around fraud-prevention.
Various types of banks such as the public sector, private sector and co-operatives are all vital cogs in the wheel for the Indian economy and are all needed for the next phase of economic growth. Primarily, the distribution reach that such an extensive network of banks provides is the underpinning of the credit framework. To ensure that much-needed credit reaches across the country, both regulations and the implementation of the said regulations need a further push.
(The views expressed in this article are personal and that of the author. The author heads Development Tracks, an infrastructure advisory firm. You can contact him at [email protected] or @Taponeel on Twitter)