Audit deficiency, not change of management, root cause of distortion in SBI March quarter results  

July 6, 2011

‘Big bath’ in balance sheet of the State Bank of India and the bloodbath on the stock price were a result of the deficiency on the part of statutory auditors who failed to guide the management properly

Gurpur

Despite all the clarifications given by the newly-appointed chairman of the State Bank of India (SBI) and his admission that this was a mistake and it should not be repeated in future, the controversy about the earnings management techniques—euphemistically called 'big bath'—refuses to die down, and it continues to haunt the stock price which has fallen by nearly 25% from a high, just before the publication of the annual results on 17th May.

It is a known fact that the quarterly results published by all listed companies are required to be vetted by the audit committee of the board (ACB), before being approved by the board of directors of the company. This is a requirement under the listing agreement with the stock exchanges, and in tune with this requirement, the ACB of every bank has been charged with the responsibility by the Reserve Bank of India (RBI) to ensure that the financial results are first approved by it before being presented to the board of the bank. The ACB is vested with powers to summon the auditors who do the limited review every quarter and to seek any clarifications in the matter of the quarterly results placed before them. On the basis of the feedback received from the statutory auditors, the ACB is within its powers to modify the account statements before presenting to the board, if felt necessary.

To be fair to the outgoing chairman OP Bhatt and the new chairman Pratip Chaudhuri, it is necessary to mention here that both these gentlemen were not members of the ACB of SBI throughout the year 2010-2011. The former chairman was not a member of the ACB, as being chairman and CEO, he was not permitted to sit on this committee as per the guidelines of the RBI. And the present chairman was not even a member of the board of SBI in 2010-2011, as he was only a deputy managing director (not a member of the board) in charge of international banking, till he was elevated as chairman on 7th April. So obviously, both these gentlemen had no direct role in finalising the results of the Bank for the first three quarters of 2010-11, which was the main responsibility of the ACB, chaired by an independent non-executive director, who was also a chartered accountant by profession.

On going through the notes to the accounts, published along with the quarterly results announced by the SBI during the first three quarters of the financial year 2010-11, it is evident that the Bank has failed to provide on a pro-rata basis the required provisions in respect of the pension liability as per the ninth bipartite settlement entered into by the Indian Banks Association (on behalf of member banks) with the All India Union of Workmen and Officers at the industry level, as early as on 27 April 2010.

The results announced by the SBI on 12 August 2010, for the first quarter of the financial year, was silent about the provision required to be made for the pension liability, as possibly no estimation would have been done by that date to provide for in the accounts. But the second quarter results published by the Bank on 8 November 2010 clearly mentioned, that "the pension liability has been projected without considering the ninth bipartite settlement as the government has not yet approved the revision in salary for pension in case of the bank."

The results for the third quarter ended 31 December 2010 announced by the Bank on 22 January 2011 also did not provide for this pension liability and the notes on the accounts stated that "the pension liability has been estimated without considering the ninth bipartite settlement, as the final approval from government for revision in pension on the basis of the revised salaries is awaited."

Both these statements obliviously indicate lack of appreciation of the normal accounting requirement of providing for the impending liability. The approval from the government was a mere formality, as the revision in salary and pension benefits were agreed to with the blessings of the Government of India and should not have been an excuse for not providing for such a huge known liability, more so when most of the other public sector banks had made provision on a pro-rata basis in the earlier quarters.

What added to the woes of the Bank was the one-time hit of Rs500 crore provided during the last quarter, to meet the additional provisions stipulated by the RBI for the teaser home loans.  According to media reports, this provision was discussed while finalising the third quarterly results, but the auditors did not insist upon this provision as the Bank expected a reprieve from the RBI in this regard and deferred making this provision too.

The last straw on the camel's back was the Bank's decision to comply with the revised guidelines issued by the RBI on 21 April 2011, to create a countercyclical provisioning buffer of Rs2,330 crore at one stretch in the last quarter, to achieve the provision coverage ratio of 70% by September 2011.

The cumulative effect of all these failures, to make appropriate provisions during earlier quarters, resulted in this unmitigated disaster of showing a paltry profit of Rs20.88 crore for the last quarter of the year, as against Rs1,866.60 crore in the previous corresponding quarter.

If the required provisions were done during the earlier quarters on a pro-rata basis, the provision requirement during the last quarter would not have been that high, and this distortion in declared profits could have been avoided, though it would not have made any difference to the annual results published by the Bank.

Here are a few lessons to be learnt from this unsavory episode.

1. It need hardly be said that the auditors have a duty to guide the bank's management to comply with all accounting requirements and insist upon full compliance without fear or favour.

2. The onus of ensuring compliance of all the accounting requirements rests with the ACB as well, that has all the power to seek any clarification it needs in the discharge of its duties.

3. A bank of the stature of SBI can hardly afford to face such ignominy and this can affect the credibility of the entire banking industry in our country.

4. The stock market is a barometer not only of the performance of the listed company but also an evaluator of good governance practices it follows, and both these factors are reflected in the stock price, as it happened in the case of SBI.

(The author is a banking and financial consultant. He writes for Moneylife under the pen name 'Gurpur'.)