A useful manual that holds back the thrill

An instance of just how conservative the Reserve Bank of India (RBI) is that after the new guidelines in 1993 for issuing bank licences, the RBI issued licences to just nine out of a total of 67 applicants, three to existing financial institutions and the others to private promoters.

Yet, less than a decade later, the majority of the new banks faced crises—Global Trust and Times Bank have already been merged, Bank of Punjab, Centurion Bank and ICICI Bank faced a depositors’ run and IndusInd Bank, to quote the author of Value Reporting and Global Comparative Advantage, could also be getting into some problems. Why is the RBI getting it so wrong?

Vipin Malik, who’s been on the board of the RBI, various financial institutions as well as various public sector banks, has some interesting answers.

Sadly, from the point of view of this book, however, he’s chosen to be quite telegraphic about the specific instances. So we learn from the book of a meeting Malik sat in with the RBI deputy governor (D R Mehta, it would appear from the timing) and raised questions as to what criterion had been used to select promoters for the licence.

While we know that Malik objected, the fact that the licences were issued suggests some arm-twisting somewhere—sadly, Malik doesn’t tell us what this was except to say “the level of (due) diligence (done by the RBI) left many holes … unless there was some compelling reason behind the due diligence conducted the way it was”.

Malik’s two-part opus on the banking sector that took close to two years to complete, is similarly silent on why the RBI allowed a change in the Bank of Rajasthan’s chairmanship—despite the fact that he himself raised objections to this after reading the reports of a central investigating agency on the subject.

Since the interesting bits aren’t there, the question is: what is? While the book is an excellent technical compilation of things bankers and corporations need to know, like the details of various laws that govern the issue of lenders’ liability in the absence of a specific piece of legislation, it has interesting themes for the non-technical readers as well.

So, for instance, there’s an exercise to show just what would happen to the incomes of some Indian banks if their accounts were subjected to US GAAP standards.

While Oriental Bank of Commerce’s net income for 2003 would rise by a fourth, that of HDFC Bank would fall by 9 per cent while that of ICICI would fall by 169 per cent!

Malik’s assertion that the whole profit of the Indian banking sector can be wiped out if the provisions for investments for projects-under-implementation are made tighter is an equally frightening statistic on the strength of the financial system (disguising bad loans as “projects under implementation” is an old evergreening trick).

The book’s USP of course is the complex modelling Malik has done to be able to evaluate the performance of banks. While such exercises have been conducted before as well, Malik’s model incorporates a host of new parameters as well—interestingly, it appears, neither public sector nor Indian private banks disclose details of their major clients and sector exposures, an important factor in Malik’s evaluation model.

How good the model is, of course, not something a non-specialist can evaluate, but it’s interesting that it shows up results which can be quite different from other models. Bank of Nova Scotia, for instance, is ranked A+ by Standard & Poor’s whereas its Indian branches get ranked as “C” by Malik’s model, which means “weak level of overall performance”.

While banks like Global Trust get a “C” on all attributes, Malik doesn’t explain why the RBI never caught on to this till the very end. The model has an interesting section on the time mismatch between interest rate sensitive assets and liabilities—Andhra Bank, which is ranked B -1, for instance, has a mismatch of 149 per cent in the 1-14 day period and 127 per cent in the 6-12 month period, a serious problem at a time when interest rates begin to rise as they are now.

A problem the book faces as it attempts to be a complete manual for bankers on areas like risk management and the new Basel norms is that the narrative becomes weak in various places.

The chapter on risk management details how banks need a risk management committee, a risk officer and so on (an organisational approach), for instance, but doesn’t delve into what’s wrong with the way banks handle their portfolios today.

Planning Commission Advisor Pronab Sen, for instance, is of the view that even in the US around 2 per cent of loans go bad each year and that’s exactly the situation in India today—Indian NPAs, however, appear much larger because banks don’t write them off as aggressively and that’s because they don’t earn enough to be able to do this.

The moral then is more lending, and not necessarily more risk management, according to Sen. This may or may not be right, but Malik doesn’t get into areas which call on him to take a firm view on such issues. His approach is more an organisational one.