Recent incidents of international bank failures have demonstrated that lenders can get into a trouble for operating a fundamentally flawed business model, hence they should be aware of potential downside risks associated with their approach, RBI deputy governor M K Jain said on Wednesday.
His remarks came two days after RBI governor Shaktikanta Das shared similar views during a meeting with top managements of lenders, saying the central bank has come across instances wherein some banks have attempted to conceal the true status of their stressed loans through the use of “smart” accounting processes.
While interacting with boards of public and private sector banks, Jain said, “Sometimes banks follow inherently risky strategies with the confidence that their bank has mitigating controls.”
“However, their assumptions may not hold true either due to internal control failure or due to exogenous factors,” Jain added.
The deputy governor said a bank’s board plays a vital role in independently assessing their business model and its attendant risks, and it is important for banks to carefully assess their own unique circumstances and capabilities, conduct thorough analysis and tailor their strategies accordingly.
While it can be valuable to learn from the experiences of other banks, adopting their strategies without considering the specific context and requirements of the organisation may lead to unfavourable outcomes, he said.
Due to rapid technological changes happening globally, banks will have to transform like technology companies, continuously innovate and invest in system upgrade, he said, adding that this has also increased risks of cyber-attacks, data breaches and operational failures.
Further, there is an operational risk arising for banks due to factors such as high attrition, lack of succession planning, skilling of staff and outsourcing services, he said.
“Operational risks stemming from ethical issues at the operating level can also have significant repercussions for banks, including reputation damage, legal and regulatory consequences, erosion of customer trust and adverse financial impacts,” he added.
Jain said banks perform the function of liquidity and maturity transformation which makes their business inherently risky.
“Effective governance requires a competent and independent board effectively overseeing the management by asking the right questions, formulating appropriate strategies, keeping in mind the risk appetite as well as establishing proper policies and procedures,” Jain said.
He added that often when supervisors detect serious issues such as non-compliance, divergences from IRACP norms and gaps in internal controls, it is reported that these concerns frequently surprise directors when presented in risk assessment and off-site analytical reports.
Therefore, boards should reflect on why critical deficiencies go unnoticed, despite having access to relevant data and assessments and work on building internal capabilities to identify and address such issues at an early stage.
“Sometimes supervision is viewed as intrusive. Let me clarify that supervision is neither designed to be intrusive or punitive nor are supervisors the risk managers of supervised entities,” Jain said.