Banking Reforms--The Right Direction

Banking Reforms – The Right Direction

Preface

There has been a lot of speculations and discussions being held in the media, social networking sites, informal forums and friendship circles regarding the reforms anticipated and/or required in the banking industry in the near future.

Let us see what they are and also analyse their positive and negative implications for all stakeholders and the country as a whole.

Government Intervention

Starting with constitution of boards of PSU Banks with the induction one director from Ministry of Finance and another Director from RBI, the union government openly interferes in banking policies and their day to day activities, beyond a point.  Licensing for new branches including upgradation, Directed Lending (Government Sponsored Programmes), Interest Waivers, Rescheduling of Agricultural and other Term Loans, huge Loan Waivers/write-off, Financial Inclusion, fixing of Recruitment and Promotion policies and guidelines, Reservation for OBC/SC/ST, Disciplinary Matters and finally determining the overall wage structure of bank personnel are totally controlled by Department of Financial Services, Ministry of Finance, New Delhi.  Many of the areas stated above in private sector banks are also highly influenced by the union government, through RBI. 

All the ruling parties use the banking system to promote their political ambition and spread their cult and power without any shame.  Thus, there is too much of meddling in the affairs of Indian banking industry.  This leads to indecision, corruption, mismanagement, diversion of funds and lack of accountability at the top management level.  This has an adverse impact on all the stakeholders – customers (depositors/borrowers), staff and the shareholders.  To check this phenomenon, the government’s role must be curtailed to the barest minimum and banks must enjoy full autonomy with suitable checks and controls which I will describe later.

Branch Licensing

Branch Expansion shall be directly linked to the profitability of the bank concerned, to prevent indiscriminate branch expansion.  There is a mad scramble among most of the banks now to open new branches, without properly studying their viability and growth in the long run.  Haphazard branch expansion greatly affects the manpower planning too.  There is skewed deployment of manpower, creating huge imbalances.  The cost of technology is not gone into before any decision with regard to opening a new branch is taken.  I suggest these measures to reverse this trend.

Banks shall not open branches outside the municipal/corporation limits, but within the Urban Agglomeration area, by obtaining licence under rural/semi-urban category.  In other words, branches situated within the Urban Agglomeration area will be classified as ‘Urban’ or ‘Metropolitan’ as the case may be.

Number of Extension Counters and Satellite Offices shall not exceed 5% of the number of full-fledged branches.   Mobile Banking may be considered in rural and semi-urban centres, for extending basic services of opening of accounts, deposits and withdrawals of cash/cheques and offering ATM, Debit Card and remittance facilities (DDs, Pay Orders, RTGS and NEFT).   All other banking services must be handled by full-fledged bank branches only.  The Banking Correspondents Model and Banking Facilitators Model are not workable, because they are fraught with risks and dangers.  Even Ultra Small Banks cannot be successful for long.  All these will fail, one after another, causing great financial loss and loss of reputation to the banks. The basic premise of ‘financial inclusion’ itself is faulty, as in the absence of Banking Correspondents, Banking Facilitators and Ultra Small Branches, the financial inclusion as envisaged now will never happen.

Categorization of Banks

Categorization of banks is done based on certain performance parameters like Net worth, Ratio of Tier I Capital to Tier II Capital, Aggregate Business, Net Profit, Capital Adequacy Ratio (CRAR), Net Interest Margin, Earnings Per Share, Current Market Price of each share vis-à-vis its Face Value, Price-Earnings Ratio, Quality of Human Resources as evidenced by Average age of an employee, Average Academic Qualification of an Employee, Training & Development policies and initiatives, Aggregate Business per Employee and Net Profit per Employee, Provision Coverage Ratio, Number of Loss Making Branches (branches which are less than 24 months old are excluded for this purpose), Incidence of Frauds, their Magnitude and Potential Losses thereof etc.  Besides, geographical area of operations (branch network) also must be reckoned.  Basing on these parameters, banks may be broadly classified into 3 major categories – ‘A’, ‘B’ and ‘C’.  To avoid volatility and distortion, the past 3 years average figures may be taken to arrive at a realistic score.

Autonomy of RBI

RBI shall confine its role to determine the broad policy framework for various banking functions and shall not poke its nose into the minute details of their implementation.  Thus, RBI’s role vis-à-vis other banks will be restricted to 1. Policy maker, 2. Regulator, 3. Bankers’ bank and 4. Lender of the last resort.  Currency Issue and Management will be an additional function of the nation’s central bank. RBI must closely monitor banks only in a select, critical areas and stop interfering in other areas of banking.  RBI must determine the range of interest rates i.e. the maximum and minimum thresholds only.  Individual Banks must be given full freedom to fix their own interest rates and service charges themselves within this range/band in a transparent manner.  But, interest rates must be revised only once a month by the banks.  Service charges will undergo revision once in a quarter. There shall not be any discrimination between customers who are similarly placed, as far as the banks are concerned.  Between different categories of customers also, for the same product or service, there shall not be a price difference of more than 15%.

RBI must conduct annual inspection of all banks either by deputing their own officials or by engaging the services of reputed chartered accountant firms/companies by rotation. For any supervision failure that results in a big financial loss, RBI must take responsibility. RBI must conduct open market operations (OMO) to regulate foreign exchange rates, as is being done now.  Similarly, to address short term liquidity issues faced by commercial banks, the existing tools of Repo, Reverse Repo and Marginal Standing Facility must be continued.   Bank Rate has lost its relevance, after the introduction of Base Rate system in banks and hence, it may be phased out.  While the money market will remain under the jurisdiction and control of RBI, the capital market (including mutual funds and debt market) will be regulated by SEBI.

Mergers

Mergers of banks shall be contemplated only when (1) a bank is unable to carry on its activities on healthy lines (incurring continuous losses or earning only meagre profits for several years) (2) when there are a spate of serious complaints against a bank from customers, general public and others, but the bank is not willing to/capable of resolving such complaints amicably (3) when a bank is unable to overcome its temporary setbacks and merger is the only way out in the interest of its customers, staff and the nation and (4) a bank willingly wants to get merged with another Indian Bank for which consent of staff and shareholders of both the banks, RBI and the Ministry of Finance is obtained.   The Government of India may also order merger of one bank with another, if the former does not function within the broad policy framework laid down and is found to have violated many Indian laws, thereby seriously jeopardizing the nation’s economy and poses a threat to the sovereignty of the nation itself.

Merger of all RRBs with NABARD

Rural branches of all public sector banks must be merged with NABARD.  Similarly, all RRBs must be merged with NABARD.  For this, the government must draw a suitable roadmap, so that the entire process is completed within the next 3 years period.  If necessary, the Government of India must provide additional capital of adequate size to NABARD for this purpose.  In future, no commercial bank will be compelled to open any branch in rural areas.

Closure of Bank Branches

Bank branches may be allowed to be closed down or merged with a nearby branch of the same bank under the following circumstances.

1. The branch is incurring losses for 5 years in a row (in case of rural/semi-urban branches) and 3 years in a row (in case of urban/metropolitan branches).
2. The branch business remains stagnant or its average growth during the past 5 years is less than 6% p.a.
3. There is a grave security threat to the existence of the branch in its current location. Staff are vulnerable to attacks by violent and radical groups and the government is unable to guarantee the physical safety of the bank staff and the customers visiting the premises.
4. The branch is located in a remote place and accessibility to it is very difficult and because of this, administrative control is weak and ineffective.
5. There is another bank branch functioning within the radius of 3 KMs.
6. Consequent on the merger of two banks, there will be two branches of the same bank in the post- merger scenario.
7. Any other reason with the consent of RBI and approval of the state government concerned.

Ownership and Control

No single individual must hold shares exceeding 1% in any bank. In case of companies registered in India, this ceiling is 3% per company and 10% for all companies in the same group, as far as shares in one bank is concerned.  However, for financial institutions registered in India, this ceiling is fixed at 20%.  For FIIs, this ceiling is 3% for one single institution and 15% for all FIIs put together.  FIIs cannot appoint any director on the board of the bank in which they have shareholdings.  No bank in India shall buy or lend against shares of another bank in India.  Any company, trust, fund or financial institution cannot invest more than 20% of their net worth in bank shares.

As for voting rights, the ceiling is prescribed as follows.

(a)   Individual – one vote per equity share subject to a maximum of 1% of the total shareholding

(b)   Companies registered in India – one vote per share, subject to a maximum of 5%

(c)   Companies/Institutions registered abroad – one vote per share, subject to a maximum of 5%

(d)   Financial Institutions in public sector – one vote per share, subject to a maximum of 15%

(e)   Promoters, their relatives and friends – one vote per share during the first 5 years and after 5 years period, there will be a ceiling of 10% for the promoters and their group (This rule applies to private sector banks and Government as the promoter of PSBs is not bound by this rule).

(f)    One single individual/group/entity cannot have more than 1 Director on the board of a bank.

(g)   Banks can have only professionals from the fields of Banking, Economics, Law, Accountancy, Company Secretaryship, Management and International Business with not less than 10 years experience in their respective fields, as whole time Directors. 

(h)   Two thirds of Directors of each bank board must be whole time Directors, as described above and

Part-time Directors shall not exceed one third of the number of Directors on the bank’s board.

(i)     For big ticket advances, the top management of each bank and their whole time Directors must be held responsible.  ‘Big ticket advances’ mean any advance exceeding Rs.10 crores per borrower/group and this limit may be suitably revised by RBI, every 5 years.

Prudential Lending Policy common to all banks

Once borrowed money from a bank/financial institution, name, photo and other details of every borrower must be uploaded in the Central Registry of Borrowers which can be accessed by all banks and financial institutions in India.  As a general rule, an individual cannot borrow from more than 2 banks at a time. Similarly, a firm/company/society/trust/association cannot borrow from more than 3 banks at a time.   However, for aggregate limits exceeding Rs.250 crores (aggregate of funded and non-funded limits), this number may be raised to 5.  For aggregate limits exceeding Rs.5,000 crores (aggregate of funded and non-funded limits), this number may be raised to 10 and not more.

Where one company has invested in its subsidiary company in the form of equity or inter-corporate deposits or loans and advances, both the holding company and its subsidiary company must jointly execute all the loan documents.  Where more than 2 banks have lent money to a single company or a group, joint lending agreement/inter se agreement amongst all the lenders is a must.

No loan/advance exceeding Rs.2 lakhs shall be given without a third party guarantee. For any loans above Rs.10 lakhs, collateral security is a must. 

Where the primary security is an immovable property and its market value was more than 100% of the loan amount at the time of disbursement, the condition for a collateral security may be waived.

For agricultural loans above Rs.10 lakhs, a suitable third party guarantee must be given.  For agricultural loans above Rs.25 lakhs, collateral security is also required in addition and this collateral security shall be a non-agricultural property like House/Flat, Factory, Government Securities, Bonds/Debentures (which are listed and regularly traded), Bank Deposits and Gold (preferably in demat form).

Loan Appraisal

Proposals involving aggregate limits of Rs.10 crores and above must be appraised by two parallel teams of staff from two different zones or one by staff team and another by a chartered accountant firm not connected to the bank concerned.  This cut-off limit may be periodically revised by RBI.  Officers working in credit departments must be compulsorily moved out after 3 years to other departments of the bank.

Loan Compliance

One or more senior officers from the credit monitoring department of the controlling office may be designated as ‘Compliance Officers’.  These officers will have rich experience in credit, law and branch administration for not less than 10 years.  They will always be on tour and visit the branches where a loan/advance for Rs.1 crore and above is due for disbursement.  They will verify and ensure the correctness of documentation, charge creation, insurance, borrower’s margin and end use of funds.  Only after they certify that all the terms and conditions of sanction have been duly complied with, disbursement will be allowed.

Charge Creation

Wherever stipulated and taken as securities, immovable properties will be secured through creation of “Mortgage by Conditional Sale”.  In the event of default, the sale will become ‘absolute and complete’, after 180 days from the date of default.  However, during this period, the owners of the property will have the first right to repay the advances and claim back their property.  Once the loan is fully paid, the sale as per the terms of the mortgage will automatically become ‘null and void’.  

To avoid misuse of this provision, the following categories of loans are exempted.

1. All Education Loans up to Rs.25 lakhs
2. All Housing Loans up to Rs.10 lakhs
3. All other loans below Rs.5 lakhs
4. Where the security is agricultural land measuring less than 5 acres.
5. Where the repayments made so far have exceeded the principal amount plus a notional simple interest of 6% p.a. calculated on monthly diminishing balances.

All mortgaged properties will be invariably registered with the Sub-Registrar’s Office concerned.  For this purpose, the stamp duty payable is 1% of the loan amount, subject a maximum of Rs.5,000.  For registration of the mortgage, a flat registration fee of Rs,1,000 is payable, regardless of the loan amount. This stamp duty and registration charges will be uniform throughout the country.

Income Recognition and Asset Provisioning

The definition of ‘non performing assets’ must undergo drastic changes.  I propose the following changes.

1. In Indian society, 90 days is too short a period, for the purpose of defining a loan/advance as NPA.  Therefore, it may be refixed at 6 calendar months, from the date of default. (Let us not simply copy international norms and procedures in unwanted areas.  We have not implemented labour welfare measures as practiced by developed nations for bank staff).
2. In case of Overdraft and Cash Credit accounts, amounts deposited to cover the interest debited shall not be allowed to be withdrawn again, even if the liability is within the Limit and Drawing Power.  Only credits exceeding interest debits will be allowed to be withdrawn.
3. Deposit Loans and Gold Loans must be exempted from the concept of NPAs, provided the liability is below the value of the security.
4. All shares, mutual fund units, government securities and LIC policies will be outside the ambit of NPA, if they are readily marketable and their redemption/market price is more than the outstanding liability.  There will be a detailed procedure laid down to determine the market price of an asset.
5. Staff Loans must be exempted from NPAs, if the amount in default can be recovered from future salaries.  However, departmental action may be taken against such staff members, if the default is intentional and continuing for more than 3 months.
6. When the interest is promptly being serviced, even if a few instalments are in arrears, such loans need not be declared as NPAs.  However, if the instalments are due for more than a year, such loans will be classified as NPAs, to the extent of the overdue amount only.
7. Where some aid/subvention/subsidy/incentive is expected from the Government within the next 6 months, such loans also need not be classified as NPAs, provided such amount of aid/subvention/subsidy/incentive is adequate to take care of the unpaid interest and instalments.
8. As far as income recognition and asset provisioning are concerned, only the interest on the overdue amount must be reversed, if already taken to Profit & Loss Account. 
9. Similarly, provisioning must be done only on the overdue amount, not the whole liability.  This is a major departure from the present system.  The underlying logic is all NPAs are not irrecoverable.
10. Nevertheless, in case of fully unsecured advances, the current system will continue.
11. In case of advances secured by tangible assets to the extent of 125% and above at the time of disbursement of the loans, the income recognition and asset classification norms will apply on the unsecured portion only.  Here, the current liability is the criterion to determine the extent of security available.
12. These revised norms with suitable modifications may be implemented within a year or so.

Recovery Mechanisms and Tools

For recovery of loans secured by pledge/hypothecation also, public notice through newspapers is needed, especially when the value of the securities is above Rs.10 lakhs.  However, securities like bank deposits, government securities, LIC policies, Shares, Bonds and Debentures (listed and actively traded) and gold ornaments are exempt from this condition.

Where the loan/advance amount is not disputed by the borrowers, they must be advised to deposit 60% of the principal amount in an escrow account with another public sector bank, before they raise any dispute with regard to interest rate, calculation of interest etc.

Where the rate of interest charged by the lender/s is challenged by the borrowers, they must pay at least 75% of the simple interest at the contracted rate, before pursuing the matter through Courts/DRT.  The interest serviced will be immediately credited to the respective loan account and taken to Profit & Loss Account.

However, the borrower may be granted 3 to 6 months time for payment of the balance amount.  The DRT/ High Court shall decide the case within 3 months from the date of filing of the suit.  The maximum number of sittings for DRT/High Court will be 5.

In case of consortium advances, a team of recovery officers drawn from each lending bank must be constituted.

Where the loan was sanctioned at the behest of a government department/agency, it is the primary responsibility of such department/agency to actively participate in recovery proceedings.  Moreover, the lending bank has every right to stop lending further under the same scheme or any other government scheme, when the overdues constitute more than 20% of the aggregate limits sanctioned under government lending programmes.  Branches which are less than 5 years old shall not be compelled to entertain any proposals under government sponsored schemes.

If the Union Government or any State Government decides to write off or absorb interest on any bank loans, first the unpaid interest must be remitted to the banks upfront.  Then only, the banks will reduce the interest liability in the loans.  In other words, such payments received from the government will be reflected in the loan account, as and when credits are received from the government.

The same principle will apply to whole sale write off of bank debts, upon the directives of the government.  Without receiving the amount outstanding in the loan accounts in full, such loans cannot be written off.  So, there will be no loan waivers or en bloc write off of bank loans.  This is introduced with a view to insulate the banks against political decisions which are populist in nature and are aimed at capturing the vote bank.

Corporate Debts and Restructuring

No loans and advances (funded or non-funded) will be granted to any company, in the absence of the personal guarantee of promoter directors (professionals/technocrats occupying director posts, by virtue of their academic qualifications and experience will not come under the definition of promoter directors, provided they do not own more than 2% of the shares of the company in their name and in the name of their relatives).  All funded limits to a company will be secured by tangible assets of not less than 60% and non-funded limits secured by tangible assets of not less than 30%. 

Whenever a proposal comes up for restructuring of advances in the name of a company (whether under consortium or not), the proposed sacrifice in all forms put together shall not exceed – (a) 15% of the shadow liability and (b) 20% of the real liability.  Moreover, where additional limits are sought to be released, upfront payment of reasonable cash margin must be demanded from the company.

Banks may take a liberal view in matters of (a) conversion of compound interest into simple interest (b) reduction of interest rate by 25% and (c) reduction of cash margin (not total waiver) for non-funded limits of sick companies. 

Banks may at the time of corporate restructuring demand the following –

(a)   Changing some of the directors on the board of the company or superseding the entire board of the delinquent company

(b)   Inducting one or two additional directors as whole time directors

(c)   Conversion of a portion of the debt/term loans into equity share of the company

(d)   The directors of the company must bring down their shareholding by a certain percentage, by offloading their shares in the open market, but not selling to their own relatives or friends

(e)   Bringing in new technology or process or both as a pre-requisite for CDR

(f)    The directors of the sick company must quit the board of all other companies in which they are whole time or part time directors

(g)   The directors who had to quit, upon the banks’ advice, must not be reappointed on the board of any company in future

(h)   Nor any relatives of such persons be appointed the directors of the companies

(i)     The company is to sell off some idle or superfluous assets like land or building (Guest House/Residential Building etc.) and reduce the liabilities or repay some loans in full

Restructuring of any advance involving aggregate limits of Rs.10 crores and above must be subjected to CAG audit.  Similarly, writing off bad debts exceeding Rs.50 lakhs and above will be closely scrutinized by the Comptroller & Auditor General.  Further, investments and purchases of large value made by banks are also to be brought under CAG Audit.

Corporate Governance

Transparency and Accountability form the bedrock of Corporate Governance.  Where substantial issues of fair banking practices are involved, RTI will cover even individual matters.  Disclosures by banks without being asked or compelled by anyone will cover more areas.  Delays and indecisions must be properly explained for.  Managers of impeccable character and highest degree of honesty and integrity must be appointed at critical positions. They must be given enough freedom in decision-making and extended full support and protection for their actions too.

Two Language Formula

In Banks, only two languages must be adopted.  For simple functions like cash/cheque deposit, withdrawal of money through cheques (or withdrawal forms in case of SB accounts), Demand Draft applications, SB Account opening etc., the necessary forms must be printed in the local vernacular language and English.  In all other cases, all forms must be printed only in English, because English has come to stay as the business language.  While customers are not compelled to write in English, banks need not waste crores and crores of rupees in printing all forms and registers in Hindi and spending huge amounts by keeping a separate department for Hindi.  People in Hindi heartland will not be affected by this change, because in their case, Hindi will be the local vernacular language.

H.R. Issues

All public sector banks will have uniform policy framework with regard to Staff Wages, Bonus, Pension, Gratuity, Provident Fund, Recruitment, Training, Placement, Promotion and Transfers, with minor changes here and there.   As a first step towards introduction of 5 day week in banks, second Saturday of every month must be declared a public holiday for banks. 

Business Hours will be reduced to 5 hours a day and banks will handle customers’ transactions from 10-00 AM to 01-00 PM and again from 02-00 PM to 03-00 PM on Week days and on Saturdays, the timings will be from 10-00 AM to 01-00 PM.  Working Hours will be from 10-00 AM to 05-30 PM on Week Days and from 10-00 AM to 03-00 PM on Saturdays.  Lunch time will be from 01-00 PM to 02-00 PM on each working day.  These timings will apply to award staff and officers uniformly.

For officers of public sector banks, Administrative Tribunals and Appellate Tribunals are to be established at all state capitals.  ‘Whistle Blower’ Act is to be enacted with necessary seriousness.  Separate Vigilance Commission for all banks – public or private – is to be constituted.  Most of its administrative staff will be drawn from the banks themselves.

Recruitment to permanent vacancies shall never stop.  ‘Outsourcing’ of routine bank jobs shall not be allowed in core areas.  For instance, in cleaning the branch premises, outsourcing may be permitted, but in cash remittances, security etc., outsourcing will only be counter-productive and hence is to be avoided.

Reservation in bank jobs must be restricted to entry level only and in promotions, no reservations will be entertained.   Direct recruitment in bank jobs must be restricted only up to 20% in Sub-staff to JMGS I, up to 10% in MMGS II and MMGS III and only up to 5% in SMGS IV.  Thereafter, no lateral entry will be permitted.

The number of Grades in Officers cadre must be brought down to 3 from the present 7.

Separate Protection force on the lines of CISF for Banks

A separate police force named as ‘Banking Protection Force’ is to be raised to guard and protect all public sector banks’ assets and their staff.  However, to prevent the entry of corrupt elements into such force, necessary precautions have to be taken.

Conclusion

Without simply imitating western economic models, we must evolve a dynamic and vibrant model suiting the uniqueness of our nation.  There shall be a clear path to be followed by all bankers, irrespective of one’s faith and belief.  Cost-benefit analysis is to be done, wherever necessary. While profit is not the only motive of banks, loss making transactions shall not be taken up. Instead, banks may be encouraged to expand their activities in the sphere of ‘Corporate Social Responsibility’. Banking shall be strictly confined to core areas of banking. For earning a few crores of rupee as non-interest income, let us not waste precious human resources who are invaluable to the nation.  We shall be consistent, unswerving and determined in our approach and action.  We will integrate banking will all other fields smoothly and perfectly, so as to walk towards a better, promising tomorrow.

Date:02-06-2014                                                                                                                         BY     pannvalan