Indian Banks: Broken Windows and Musical Chairs

It is easier to summarise what is right with Indian banks than to detail what is wrong . Tragically, nothing seems to be right. SBI, BOB, PNB, Allahabad Bank, IOB, etc., all of them seem to be neck-deep in mismanagement and consequent ill-effects.

SBI has started reporting quarterly loss. BOB has closed its branch in South Africa. PNB has been forced to go to town regarding its incapacity to comply with basic banking requirements. Allahabad Bank is a participant in all big bad loans. IOB is in perennial penury. Banks not named here are perhaps waiting for an opportune time to disclose their distress.

When the entire system is rotten, neither RBI nor the Finance Ministry can escape their responsibility. We do not have a responsible and reasonable opposition party that can pin  down the government for its lapses and facilitate remedial steps. In essence, the entire banking system is broken.

According to the theory of Broken Windows, if even a single window is broken in a house, over time,  vandalism can be expected. If all windows are broken?

Frauds are committed over a long period of time as in the case of Nirav Modi. Instead of rounding up all perpetrators, we catch only those who are at the wheel when the fraud becomes public. In this game of musical chairs, the borrowers are able to fly the coop because they are informed in advance as to when the music will stop.

It has become the norm for every bank whose mismanagement is exposed,  just to brazen it out till another bank gets into limelight for its recklessness. It is a never-ending saga of managerial delinquency and competitive chicanery.

IOB's controversial proposal (contd.)

This is in continuation of the post dated January 9th.

The EGM was held as scheduled on January 30th. Out of nine directors, only four made their appearance. These four included three whole-time directors. It was surprising that nominees of RBI, Government, shareholders and chartered accountants were too busy to attend. Perhaps they preferred to keep away when a controversial, sinister and path-breaking step violative of corporate governance was under discussion.

It was comforting to note that a preponderant majority of shareholders was vocally against the move though the bank packaged it, perhaps misleadingly, as a facilitator for earlier declaration of dividend. These shareholders deserve to be complimented for prioritising strict adherence to law over early payment of dividend. The few shareholders who supported the proposal are, as you would have guessed, former employees of the bank.

There was an audio-visual presentation stressing that the proposal only amounted to right-sizing the Balance Sheet. It is difficult to come across a more blatantly false interpretation of a financial statement. It was sought to be argued that the proposal would make the statements truer and fairer. What a terrible concoction of untruth and deception ! This is nothing but outlandish and unlawful window-dressing.

Why is IOB doing this? The objective is not clear. It cannot be as innocent as wanting to favour the shareholders with a quicker dividend. A bank with such a motive would not have played ducks and drakes with its credit portfolio and created this predicament in the first place.

RBI circular dated February 2, 2017 regarding Basel III Capital Regulations makes it difficult for banks with huge accumulated loss to pay interest on some kinds of bonds issued by the bank. In case a bank defaults on payment of interest, there will be disastrous consequences. It is not known if IOB is in such a crisis. It would be fitting if IOB discloses the real motive for the proposal which of course has been approved with the blessings of GOI and LIC. It is likely that GOI is viewing this as a test case to watch reactions of the public to such ingenious interpretation of corporate governance.

IOB's controversial proposal

Indian Overseas Bank was promoted by a business community (Chettiars) that is known for its conservatism and adherence to laws in letter and spirit. It is therefore ironic that IOB has now proposed to appropriate Share Premium Account to set off whopping accumulated losses. It is true that post-nationalisation, the character of banks has changed drastically. But nobody would have expected a laid-back bank like IOB to come up with a financial engineering masterpiece as it has done now.

The bank has convened an Extraordinary General Meeting of its shareholders on January 30th ( Martyrs' Day !) Is the bank making its shareholders martyrs? The move is controversial because as the bank has rightly mentioned in its notice convening the meeting, the use of Share Premium Account to set off Accumulated Losses is not envisaged in Banking Companies Act or Banking Regulation Act. As the bank conveniently states, "it is neither permitted nor prohibited". IOB's pragmatic view is stated as follows:

"The Bank is of the view that this is the most practical
and economically efficient option available to the
Bank in the present scenario so as to present a true
and fair view of the financial position of the Bank."

Does dubious deletion of Accumulated Losses by utilising funds from Share Premium Account present a true and fair view of the financial position of the bank? Since banking-related Acts are silent on this aspect of financial engineering, we can draw lessons from the Companies Act.

The Companies Act permits appropriation from Securities Premium only for five purposes. 1) to write off preliminary expenses, 2) to write off discount on issue of securities, 3) to provide for premium on redemption of securities, 4) to issue bonus shares, 5) to enable buy-back of share capital.

Therefore, a non-banking company can not do what IOB proposes to do. Banks are expected to be more conservative and are not supposed to adopt expedient measures to whitewash their financial statements. IOB's notice to shareholders hints that RBI's approval for this innovative move has been obtained. According to Banking Regulation Act (Sec 17 (2) ) and RBI's reiteration in 2006, any appropriation from Share Premium Account by a bank should be notified to RBI within 21 days with proper justification.

This proposed move will set a precedent for other banks to follow. A larger bank like ICICI Bank which is indubitably smarter in presentation of financial statements may be waiting in the wings to appropriate from Securities Premium Account to bolster its Profit and Loss Account whenever a future contingency arises. Such future contingencies are more likely than not.

IOB's asset quality: Moderation or deterioration?

Words used by credit rating agencies communicate a lot. For example, Indian Overseas Bank which continues to be plagued by profitability issues has some of its debt instruments rated by CARE and some by ICRA.

Recently, the bank sent two communications to the stock exchanges. In one communication dated October 20th, mention is made of downgrading of some debt instruments by CARE because of "continuing moderation in Asset quality and financial performance during Q1 FY 16".

Communication of October 28th contains the more blunt words of ICRA which refers to "continuing deterioration in Asset quality".

Obviously 'moderation' and 'deterioration' do not mean the same. Is CARE more issuer-friendly?

Added on Nov 7th:

Response was sought from ICRA and CARE. Their response is given below:

CARE: "Though the statements may be interpreted differently, both refers (SIC) to concerns on asset quality."

ICRA: " IOB's asset quality indicators changed over the last few years as indicated below: 

Parameter	FY12	FY13	FY14	FY15	Jun-15	Sep-15
Gross NPA	2.74%	4.02%	4.98%	8.33%	9.40%	11.00%

While the Sep 2015 results were declared after the latest ICRA rating action, the above table is quite clear that "continued deterioration" is a more appropriate representation while commenting on the asset quality of the bank. "