Reserve Bank of India (RBI) governor Shaktikanta Das said on Monday that 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.
“During the course of our supervisory process, certain instances of using innovative ways to conceal the real status of stressed loans have also come to our notice,” he said at the Conference of Directors of Banks organised by the RBI for private sector banks.
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Das noted that despite guidelines on corporate governance, these gaps in certain banks have the potential to create some level of volatility in the banking sector.
Highlighting the methods employed, he mentioned cases where some lenders used smart accounting techniques to artificially enhance their financial performance. These methods include two lenders collaborating to evergreen each other’s loans by sale and buyback of loans or debt instruments, and convincing good borrowers to enter into structured deals with stressed borrowers to conceal the stress in the loan account.
In addition, lenders were found using internal or office accounts to adjust repayment obligations, renew of loans, disburse new loans, provide additional loans to stressed borrowers or related entities close to the repayment date of earlier loans, among other practices.
“We have also come across a few examples where one method of evergreening, after being pointed out by the regulator, was replaced by another method. 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.
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Das also emphasised that the board of directors, especially the audit committee, should closely scrutinise the accounting policies followed by lenders and implement preventive controls to deter smart or aggressive accounting practices. The board or audit committees should engage with the Statutory Central Auditors of the bank to ensure transparent and prudent financial accounting.
Last week, Das had met the top management of public sector banks in Delhi, wherein the discussion was focused on improving lenders’ governance standards.
Warning about aggressive growth
Besides accounting practices, Das urged banks’ boards to pay particular attention to asset liability management (ALM), as suboptimal ALM can lead to significant liquidity risks and destabilising effects on the bank itself, as seen recently in the US banking sector.
He also noted that the developments in the US have shown that aggressive growth strategies with disproportionate or excessive focus on bottom lines or market capitalisation often result in the accumulation of vulnerabilities.
“Over-aggressive growth, under-pricing, or over-pricing of products both on the credit and deposit sides, concentration or lack of adequate diversification in deposit/credit profile can expose the banks to higher risks and vulnerabilities,” Das added.
In the digital age, the transfer of billions of dollars held as deposits in a bank to other institutions can occur within hours, leading to a severe liquidity crisis, as seen in the US. The monitoring of information appearing in various media, including social media, has become very important for any bank, he said. In fact, such cases have been observed in India too, in a few banks in the past.
“We had to advise the CEOs to interact with the media immediately to set out the facts correctly. There have been instances when the RBI had to issue press statements to assuage concerns and prevent potential panic. In this kind of milieu, it is upon the banks and their boards to assiduously build a sound corporate culture and value system within the organisation,” he said.
However, he also lauded the Indian banking sector for being in the best of health with an average capital adequacy ratio of 16.1%, gross bad loan ratio of 4.41%, and provision coverage ratio of 73.20% as of December 31. But cautioned it is during such times that complacency could set in.
“We have to bear in mind that risks often get overlooked or forgotten when things are going well. Therefore, Boards of Directors of Banks and their senior management should maintain constant vigil on external risks and build-up of internal vulnerabilities, if any,” Das said.